GUIDANCE ON THE
REPARATION OF ECONOMIC ANALYSES AND
IEGULATORY IMPACT ANALYSES IN OPPT
January 1993
Daniel Axelrad
Regulatory Impacts Branch
Economics, Exposure and Technology Division
Office of Pollution Prevention and Toxics
U.S. Environmental Protection Agency
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TABLE OF CONTENTS
I. INTRODUCTION 1
A. TSCA Section 6 and Requirements for Economic
Analysis 2
B. The Two-Stage Process for Economic Assessment of
Section 6 Rules 3
C. Relationship of the Two-Stage Process to RIAs
Previously Prepared in RIB 4
D. Scope of This Guidance Document 4
E. Organization of This Guidance Document 6
II. BACKGROUND ON REGULATORY IMPACT ANALYSIS 7
A. Executive Order 12291 and OMB Review 8
B. Criteria for the Development of Regulations 9
III. THE REGULATION DEVELOPMENT PROCESS 13
A. EPA Regulation Development Process 13
B. OPPT Existing Chemicals Program 16
IV. CONTENTS OF THE ECONOMIC ANALYSIS 23
A. Purpose of the Economic Analysis 23
B. Section-by-Section Contents of the Economic
Analysis 25
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TABLE OF CONTENTS
(continued)
V. PREPARATION OF THE ECONOMIC ANALYSIS 44
A. Planning Stage 42
B. Analysis Stage 47
C. Final Review Stage 50
D. Outline of Steps in Preparing an Economic Analysis...51
E. Role of the RIB Contractor in Preparing an Economic
Analysis 54
VI. CONTENTS AND PREPARATION OF THE REGULATORY IMPACT
ANALYSIS 55
A. Purpose of the RIA and Differences Between the
Economic Analysis and the RIA 55
B. Contents of the RIA 56
C. Preparation of the RIA 61
APPENDIX A: USING DERIVED STEP-DEMAND FUNCTIONS TO ESTIMATE
THE COSTS OF REGULATORY OPTIONS 62
1. The Step-Demand Function Framework 62
2. Implementation of the Step-Demand Function
Methodology 69
3. Previous RIB Analyses Using the Step-Demand
Framework 71
APPENDIX B: GENERIC METHODOLOGICAL ISSUES 72
1. Time Period of Analysis 72
2. Specification of a Baseline for Analysis 73
3. Definition of Regulatory Costs 75
4. Discounting Procedures 78
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TABLE OF CONTENTS
(continued)
APPENDIX C: FRAMEWORK FOR QUANTITATIVE BENEFITS ANALYSIS....87
1. Steps to Follow When Benefits Can Be Quantified
and Monetized 88
2. Steps to Follow When Benefits Can Be Quantified
But Not Monetized 91
3. Benefits Analysis When Cases Avoided Can Not Be
Quantified 92
4. Non-Cancer Benefits Model 93
5. Direct Cost of Illness Estimates 93
APPENDIX D: VALUATION OF DEATHS AVOIDED IN BENEFITS
ANALYSIS 94
APPENDIX E : COST-EFFECTIVENESS ANALYSIS 97
1. Average and Incremental Cost-Effectiveness
Calculations 97
2. Steps in Cost-Effectiveness Analysis 99
3. Graphing the Cost-Effectiveness Analysis 104
APPENDIX F: ANALYSIS OF IMPACTS 106
1. Regulatory Flexibility Analysis 107
2. Paperwork Reduction Act Analysis 108
3. Trade Impacts Analysis 108
4. Innovation Impacts Analysis 108
5. Equity Effects Analysis 109
APPENDIX 6: TEXT OF EXECUTIVE ORDER 12291 AND OMB'8
REGULATORY IMPACT ANALYSIS GUIDANCE 110
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LIST OF EXHIBITS
III-l. Standard Products in the OPPT Existing Chemicals
Process 17
IV-1. Economic Analysis Model Outline 24
IV-2. Sample Table of Cost Estimates 31
IV-3. Sample Exhibit for Presenting Quantified and Non-
Quantified Benefits Categories 34
IV-4. Sample Table of Benefits Estimates 37
IV-5. Sample Table of Net Benefits Estimates 38
V-l. Economic Analysis Model Outline 43
V-2. Contents of the Economic Analysis Development Plan...45
V-3. Model Schedule for Preparation of an Economic
Analysis 48
VI-1. Regulatory Impact Analysis Model Outline 58
A-l. Conventional Supply and Demand Framework 63
A-2. Regulatory Costs in the Conventional Framework 63
A-3. Step-Demand Framework 65
A-4. Regulatory Costs in the Step-Demand Framework With
No Substitution 65
A-5. Regulatory Costs in the Step-Demand Framework With
Partial Substitution 68
iv
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LIST OF EXHIBITS
(continued)
A-6. Regulatory Costs in the Step-Demand Framework With
Extensive Substitution 68
B-l. Spreadsheet for Calculating Present Value of Constant
Annual Costs With Increased Year 1 Costs 83
B-2. Spreadsheet for Calculating Annualized and Present
Value Costs for A Rule With Capital Costs 84
B-3. Spreadsheet for Calculating Net Benefits of a
Two-Phase Chemical Control Rule 85
E-l. Costs and Benefits of Regulatory Options 100
E-2. Worksheet for Identifying Efficient Options 101
E-3. Cost-Effectiveness Analysis Results 103
E-4. Illustration of the Cost-Effectiveness Analysis 105
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CHAPTER I
INTRODUCTION
This document provides guidance on the preparation of
Economic Analyses and Regulatory Impact Analyses in the
Regulatory Impacts Branch (RIB) of the Office of Pollution
Prevention and Toxics (OPPT). RIB prepares economic assessments
in support of rulemakings under several regulatory authorities,
including:
the Toxic Substances Control Act (TSCA),
the Emergency Planning and Community Right-to-know Act
(EPCRA, also known as Title III of SARA),
the Asbestos Hazard Emergency Response Act (AHERA), and
the Residential Lead-Based Paint Hazard Reduction Act
("Title X").
In general, rulemakings in OPPT break down into two main
categories. First, OPPT conducts rulemakings under Section 6 of
TSCA which would impose restrictions on the production or use of
toxic substances. Analyses prepared by RIB in support of these
rulemakings present estimates of the costs and benefits for
various regulatory options under consideration, such as bans on
production of a substance, bans on its use in certain
applications, or restrictions on the ways in which it may be
used.
Second, OPPT conducts rulemakings under various sections of
TSCA and EPCRA which impose information reporting requirements on
producers, importers, processors or users of chemicals. Analyses
prepared by RIB in support of these rulemakings evaluate the
costs of various options which may vary in scope of coverage—the
number of substances, firms and industries affected by the rule
requirements—and in the types and amount of information which
must be reported. Examples of reporting requirements include:
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Chapter J Introduction
information on chemicals produced, production sites, and
production volumes (TSCA Section 8(b) chemical inventory);
advance notification of production or import of a new
chemical (TSCA Section 5);
submission of unpublished health and safety studies (TSCA
Section 8(d)); and
estimated annual releases of certain toxic chemicals (EPCRA
Section 313).
The types of information required to estimate the costs and
benefits for each of these two types of rulemaking differ
considerably:
For rules which would directly affect the production or use
of toxic substances, costs are estimated through an
evaluation of control technologies, process changes and
substitutes, while benefits are estimated through an
evaluation of reduction in risk to human health and the
environment.
For reporting rules, costs are estimated through an
evaluation of the number of reports expected and the cost of
preparing each report, while benefits are estimated through
an evaluation of the value of that information.
The primary focus of this document is on the preparation of
analyses of direct regulatory controls on production or use of
chemicals, considered under Section 6 of TSCA. A great deal of
the information presented in this guidance document, however, is
also applicable to the economic analysis of other types of
regulatory activities. The following sections present background
information on TSCA Section 6 and economic analysis in RIB in
order to provide context for the remainder of this document.
A. TSCA Section 6 and Requirements for Economic Analysis
The economic assessment of TSCA Section 6 rules is driven by
the requirements of Section 6 itself as well as the requirements
of Executive Order 12291 (E.O. 12291).
Section 6(a) of TSCA grants the Administrator of EPA the
authority to regulate the manufacture, processing, distribution
in commerce, use, or disposal of a chemical substance or mixture
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Chapter J Introduction
if the Administrator finds that any of these activities "presents
or will present an unreasonable risk of injury to health or the
environment." The Administrator is empowered to apply one or
more of several possible requirements to the chemical substance
or mixture "to the extent necessary to protect adequately against
such risk using the least burdensome requirements." Even though
TSCA does not specifically discuss cost-benefit analysis, this
language implicitly calls for the use of cost-benefit comparisons
in the development of regulations under TSCA Section 6.
Executive Order 12291 requires regulatory agencies to submit
all proposed and final regulations to the Office of Management
and Budget (OMB) for review. Agencies must demonstrate to OMB
that the regulation is necessary, and that the selected
regulatory approach maximized net social benefits. For any
"major" rule , the agency is required to prepare a Regulatory
Impact Analysis (RIA), which contains descriptions of the costs
and benefits of the proposed rule and of alternative approaches.
The same types of analyses needed to support TSCA Section 6
rulemaking requirements also serve to meet the requirements of
Executive Order 12291.
The rulemaking requirements of TSCA Section 6 and Executive
Order 12291 are discussed in more detail in Chapter II of this
guidance document.
B. The Two-Stage Process for Economic Assessment of Section 6
Rules
There are two stages to the preparation of economic
assessments of proposed regulations under TSCA Section 6:
In the first stage, an Economic Analysis is produced;
In the second stage, a Regulatory Impact Analysis is
produced.
The purpose of the Economic Analysis is to develop estimates
of the costs and benefits of a variety of regulatory options, and
to provide documentation of these estimates. The goal in
preparing this report is to develop the economic information
needed to support a regulatory decision—that is, the selection
of a particular regulatory option for proposal or a decision not
The definition of a major rule is discussed in Chapter II of this
document. In practice, virtually every TSCA Section 6 rule is treated as a
maj or rule.
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Chapter I Introduction
to proceed with rulemaking.
The purpose of the Regulatory Impact Analysis is to
demonstrate to OMB that the proposed rulemaking complies with the
requirements of E.G. 12291. The preliminary RIA must present the
economic rationale for the proposed rule, including the
justification for regulatory intervention and the rationale for
the particular regulatory requirements being proposed. The
Preliminary RIA draws heavily from the Economic Analysis to
justify the proposed rule.
In addition, both the Economic Analysis and the RIA support
the finding of "unreasonable risk" required under TSCA Section
6(a) and the determination of the least burdensome requirements
to protect adequately against the risk.
C. Relationship of the Two-Stage Process to RIAs Previously
Prepared in RIB
The two-stage process described above plays a central role
in the presentation of material in this document. As of the
writing of this document, however, it is a newly-adopted process
in RIB. Even though RIB has prepared many RIAs in the past, they
do not necessarily correspond to the discussion in this document.
Many of RIB's previous RIAs correspond more closely to the
description of an Economic Analysis in this document than they do
to the description of a Regulatory Impact Analysis. The RIA for
formaldehyde—Regulatory Impact Analysis of Control Options for
Urea-Formaldehyde Pressed Wood. Draft Final Report, Abt
Associates, Inc., April 23, 1992—in particular serves as a good
model for many aspects of the Economic Analysis discussed in this
document, and is therefore referenced frequently. There is,
however, no corresponding RIB model at this time for the type of
RIA discussed in this document.
D.
This guidance document discusses the contents and
preparation of both the Economic Analysis and the RIA because of
the important inter-relationship between the two reports. While
there are many overlaps between the Economic Analysis and the
RIA, there are important distinctions which result from the
difference in the purpose of each document and from the stage in
the rule development process at which each is prepared.
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Chapter I Introduction
This document also presents further background information
on TSCA Section 6, Executive Order 12291, and the Regulation
Development Process, to provide the RIB analyst a broader
understanding of the role of the Economic Analysis and the RIA.
There are several additional issues relevant to the conduct
of economic assessments in RIB which are beyond the scope of this
document. The following topics do not receive detailed treatment
in this document:
theoretical foundations of welfare economics and cost-
benefit analysis;
data gathering methods and data sources;
analysis of information collection requirements; and
document style and formatting.
This guidance document is a companion to several other
guidance documents available to RIB staff, including:
Regulatory Impact Analysis Guidance. Office of Management
and Budget (found in Appendix 6 of this document);
Guidelines for Performing Regulatory Impact Analysis, U.S.
EPA, December 1983;
EPA Guidelines for Implementing the Regulatory Flexibility
Act. U.S. EPA, Revised April 1992;
RIB How-To Guide; RM1 Economic Reports, prepared by
MATHTECH Incorporated for the Regulatory Impacts Branch,
July 1, 1991; and
RIB How-To Guide; Use and Substitutes Reports. Regulatory
Impacts Branch, August 1991.
While this document does overlap to some extent with the
other guidance documents, its primary purpose is to address
analytical and procedural issues specific to the preparation of
major economic analyses in OPPT. Readers should therefore
recognize that there is much useful in the other guidance
documents relevant to the preparation of Economic Analyses and
RIAs which has not been incorporated into this document.
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Chapter J Introduction
E. Organization of This Guidance Document
The remainder of this document is organized as follows:
Chapter II presents background information on E.G. 12291,
RIAs, and TSCA Section 6 rulemaking criteria;
Chapter III presents a discussion of the rulemaking process
and the role of various reports prepared by RIB in that
process, including the Economic Analysis and the RIA;
Chapter IV discusses the contents of an Economic Analysis
for a TSCA Section 6 rule;
Chapter V discusses the procedures for preparing an Economic
Analysis;
Chapter VI discusses the contents of and preparation of a
Regulatory Impact Analysis for a Section 6 rule;
Appendix A discusses the application of Use and Substitutes
data in the estimation of regulatory costs;
Appendix B discusses several generic methodological issues
in cost-benefit analysis;
Appendix C presents an outline of the steps followed in
preparing a benefits analysis;
Appendix D discusses the standard estimate used by RIB of
the value of statistical lives saved for benefits analysis;
Appendix E discusses the methodology for cost-effectiveness
analysis in RIB RIAs;
Appendix F discusses the analysis of "impacts" in an RIA and
presents a methodology for Regulatory Flexibility Analysis;
and
Appendix G contains the text of Executive Order 12291 and
the "Regulatory Impact Analysis Guidance" issued by the
Office of Management and Budget (OMB).
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CHAPTER II
BACKGROUND ON REGULATORY IMPACT ANALYSIS1
A Regulatory Impact Analysis (RIA) is a document prepared by
regulatory agencies such as EPA that contains detailed
information on the need for and consequences (that is, benefits
and costs) of a proposed regulatory action. The RIA organizes
this information in a way that allows comparison of the benefits
and costs of alternative regulatory approaches.
Documents like RIAs have been prepared in support of agency
rulemakings for many years. Until the 1980s, however, oversight
of the agencies' regulatory actions was limited to ensuring that
particular regulations would not adversely affect variables such
as inflation or employment. There was relatively little concern
for the cumulative effect that resulted from the increasing
amount of regulation being promulgated by various agencies under
a growing number of statutory authorities.
With the signing of President Reagan's Executive Order 12291
(E.O. 12291) in 1981, however, the use and importance of
regulatory analysis has increased. Executive Order 12291 defines
rules as either "major" or "nonmajor," based on their potential
economic impacts. To assess these impacts, agencies must prepare
detailed studies showing the implications of their regulations.
For major rules, E.O. 12291 requires the agencies to submit their
RIA to the White House Office of Management and Budget (OMB) for
review. OMB has broad powers to request revisions to all
regulatory proposals to ensure their consistency with the
regulatory principles contained in the Order. As a result, most
rulemakings (whether major or not) are now subject to some type
of economic analysis, either in the form of a "full-blown" RIA or
a more informal evaluation.
Much of the material presented in this chapter was prepared by Eastern
Research Group.
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Chapter II Background on Regulatory Impact Analysis
A. Executive Order 12291 and OMB Review
Executive Order 12291 was signed by President Reagan on
February 17, 1981. As stated in the text of the Order, its
purpose is to:
...reduce the burdens of existing and future regulations,
increase agency accountability for regulatory actions,
provide for presidential oversight of the regulatory
process, minimize duplication and conflict of regulations,
and insure well-reasoned regulations...
The Executive Order requires administrative agencies to
forward all proposed and final regulations to the Office of
Management and Budget (OMB) for pre-publication review. The
Office of Information and Regulatory Affairs (OIRA) within OMB is
the office responsible for actually conducting the regulatory
review.
E.o. 12291 classifies regulations as "major" if they (1)
will have an economic impact of over $100 million per year, (2)
will cause other adverse economic impacts, or (3) are designated
major by OMB for any other reasons. Under E.O. 12291, an agency
proposing or finalizing a major rule bears the burden of showing
that the regulation is necessary, that regulation is the best
means available for addressing the problem, and that the
regulatory option chosen is the one that maximizes the net social
benefits.
To show that it is complying with the requirements of E.O.
12291, the agency must prepare a Regulatory Impact Analysis (RIA)
and submit the RIA, along with the Federal Register notice for
the rule, to OMB for review. The RIA establishes the need for
the proposal, the alternative actions available, the costs and
benefits of the alternatives, and the justification for the
alternative selected. It is often the key document prepared in
support of a major rulemaking by EPA or other agencies.
OMB is empowered to review all proposed and final
regulations for consistency with administrative policy and
priorities "to the extent permitted by law." Although OMB does
not have authority to veto agency rules, the E.O. does direct the
proposing agency to "refrain from publishing" its rule until the
agency has "responded to the (OMB) Director's views, and
incorporated those views and the agency's response in the
rulemaking file." If an agency disagrees with OMB's comments on
a particular rule, the only available route for appeal is
directly to the President.
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Chapter II Background on Regulatory Impact Analysis
OMB's use of the RIA to evaluate the necessity of a
regulatory proposal and its economic justification indicates how
important the RIA can be to the rulemaking effort. By the time a
regulatory proposal reaches OMB, the Agency will have invested
considerable time, effort, expense, and political will in its
development. When regulatory proposals elicit strong political
reactions (e.g., from environmental or industry groups, or from
OMB) the RIA can become the focus of considerable debate and
scrutiny.
The RIA must build a convincing case for regulation. To do
this/ it should be based on sound reasoning and methodology/
utilize the best available data/ and be presented in an
effective/ easily-comprehended fashion.
B. Criteria for the Development of Regulations
1. E.O. 12291 Criteria
Section 2 of E.O. 12291 puts forth a set of guiding
principles for the development of "good" regulations, which OMB
uses in assessing regulatory proposals. These principles are:
(a) Administrative decisions shall be based on adequate
information concerning the need for and consequences of
proposed government action;
(b) Regulatory action shall not be undertaken unless the
potential benefits to society for the regulation outweigh
the potential costs to society;
(c) Regulatory objectives shall be chosen to maximize the
net benefits to society;
(d) Agencies shall set regulatory priorities with the aim
of maximizing the aggregate net benefits to society, taking
into account the condition of the particular industries
affected by regulations, the condition of the national
economy, and other regulatory actions contemplated for the
future.
These general principles are to apply to all agency
rulemakings "to the extent permitted by law". Many statutes
administered by EPA, however, list specific factors (e.g.,
protection of public health), that are to be used as criteria for
regulation. A consideration of costs and cost-effectiveness is
sometimes noticeably absent from such laws. Even in these cases,
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Chapter JJ Background on Regulatory Impact Analysis
however, the Agency may nonetheless prepare estimates of
regulatory costs and benefits as if the principles of E.O. 12291
applied. In several cases, OMB has held up the regulatory
process by requesting cost estimates of regulations developed
under statutes that explicitly do not permit a consideration of
costs.
2. TSCA Criteria
Several sections of TSCA provide guidance on the criteria to
be used in developing regulatory proposals under its authority.
Under Section 6(a), EPA is authorized to take action when:
...there is a reasonable basis to conclude that the
manufacture, processing, distribution in commerce, use, or
disposal of a chemical substance or mixture ...presents or
will present an unreasonable risk of injury to health or the
environment...
The section then goes on to specify the actions available to EPA
for controlling such risks. These include bans on certain
products, restrictions on the quantity of the products produced,
limitations on the use of such products, requirements for
labelling, etc. EPA is required under the Act, however, to use
the "least burdensome" remedy or combination of remedies that
"protect adequately against such risk". Thus, consideration must
be given to the alternatives available and the costs or "burdens"
imposed by each.
Section 2 (Policy Findings, and Intent) is more specific
regarding the nature of the burdens that must be considered:
Authority over chemical substances and mixtures should be
exercised in such a manner as not to impede unduly or create
unnecessary economic barriers to technological innovation...
(Section 2(b)(3))
It is the intent of Congress that the Administrator shall...
consider the environmental, economic, and social impact of
any action the Administrator takes or proposes to take under
this Act. (Section 2(c))
Under Section 6 of TSCA, EPA is directed to balance the
risks from chemicals and mixtures against the benefits of their
use, and the economic consequences of actions taken to restrict
their use:
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Chapter JJ Background on Regulatory Impact Analysis
The Administrator shall consider and publish a statement
with respect to —
(A) the effects of such substance or mixture on health and
the magnitude of the exposure of human beings to such
substance or mixture,
(B) the effects of such substance or mixtures on the
environment and the magnitude of the exposure of the
environment to such substance or mixture,
(C) the benefits of such substance or mixture for various
uses and the availability of substitutes for such uses,
and
(D) the reasonably ascertainable economic consequences of
the rule, after consideration of the effect on the
national economy, small business, technological
innovation, the environment, and public health.
(Section 6(c)).
The legislative history of TSCA indicates that Congress
stopped somewhat short of requiring the use of strict cost-
benefit principles to evaluate proposals developed under the TSCA
authority:
...In general, a determination that a risk associated with a
chemical substance or mixture is unreasonable involves
balancing the probability that harm will occur against the
effect of proposed regulatory action and the availability to
society of the benefits of the substance or mixture ,
taking into account the availability of substitutes for the
substance or mixture which do not require regulation, and
other adverse effects which such proposed action may have on
society.
The balancing process described above does not require a
formal benefit-cost analysis under which a monetary value is
assigned to the risks associated with a substance and to the
cost to society of proposed regulatory action on the
availability of such benefits... (H.R. Report No. 94-1341,
p.14)
In economic analysis of regulation, the term "benefits" usually refers
to the benefits of regulation. In the statutory language of TSCA and related
Congressional documents such as the legislative history, however, "benefits"
frequently refers to the benefits of using the substance--which are analogous
to the costs of regulation.
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Chapter II Background on Regulatory Impact Analysis
Thus, although Congress did intend for EPA to fully consider
the "reasonably ascertainable" tradeoffs between the benefits of
regulation and costs of regulation, it provided EPA somewhat
greater flexibility in choosing among alternatives, in comparison
with E.O. 12291. Whereas E.O. 12291 requires the strict
application of cost-benefit analysis (where permitted by law),
and stresses the quantification of costs and benefits, TSCA
recognizes that costs and/or benefits may be difficult to
quantify. In practice, however, the criteria of E.O. 12291
closely parallel those of TSCA, suggesting that adherence to the
guidelines of E.O. 12291 is probably the best course of action
for the analyst preparing an RIA under TSCA authority.
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CHAPTER III
THE REGULATION DEVELOPMENT PROCESS
In order to place the Economic Analysis and Regulatory
Impact Analysis in context, this chapter discusses the broader
processes by which regulations are developed in EPA and OPPT.
A. EPA Regulation Development Process
EPA's regulatory development process is designed to ensure
that all requirements for rulemaking are met, including the
requirements of the Administrative Procedures Act, E.O. 12291,
the Regulatory Flexibility Act, the Paperwork Reduction Act, as
well as the requirements of the statute under which the rule will
be issued. It is also intended to allow for all EPA offices and
regions with an interest in a rule to participate in and approve
of that rule.
EPA's regulatory development process is initiated by the
submission of a Start Action Request (SAR) to the Agency Steering
Committee. The SAR is a standard form which provides brief,
descriptive information on a new rule development effort. The
Steering Committee is a group with representation from each
Assistant Administrator and the General Counsel. It is the
primary mechanism for coordinating and integrating the Agency's
regulatory development activities. The Steering Committee
reviews the SAR and determines whether coordination of the new
action with other Agency actions or programs is needed, and
identifies the EPA offices which should be represented on the
workgroup.
After the SAR is approved by the Steering Committee, the
Agency workgroup is officially formed. The Agency workgroup is
an EPA-wide, staff-level group formed to develop a regulatory
action and supporting materials. The workgroup's primary
responsibilities are to:
1. Conduct technical and analytical work, including risk
assessment work and regulatory impact analysis;
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Chapter JJJ The Regulation Development Process
2. Identify and assess principal policy issues and
options;
3. Resolve issues or elevate them for upper management
resolution; and
4. Ensure the quality and completeness of regulatory
packages, including the Federal Register notice.
Workgroup members are expected to represent the policy positions
and perspectives of their management as well as to contribute
their technical and analytic expertise.
A workgroup closure meeting is held when the workgroup has
completed preparation of the Federal Register notice for the
proposed rule and all supporting analyses, and the management of
the lead office (i.e., OPPT OD and DDs, and the OPPTS AA) has
approved the notice and analyses. The purpose of the workgroup
closure meeting is to confirm that:
1. The workgroup has successfully completed its job,
resolving as many issues as possible and clearly
defining others;
2. The rulemaking package is ready for review at the
Assistant Administrator, Regional Administrator and
Deputy Administrator level; and
3. Agency and external requirements have been met.
The workgroup closure meeting is chaired by a representative
of OPPE's Office of Regulatory Management and Evaluation, whose
role is to facilitate closure. Members of the workgroup
participate in the meeting as representatives of their Assistant
or Regional Administrators. While OPPT workgroup members attend
the meeting, they are not the focus of the meeting, because prior
to the meeting, issues within OPPT and OPPTS will have been
addressed and the package approved by the OD and the AA.
Instead, the focus is on the workgroup members from other EPA
offices or regions.
In the workgroup closure meeting, those workgroup members
from other offices or regions offer the positions of their
Assistant or Regional Administrators on the FR notice and
supporting documents. These representatives may either: concur;
concur with comment; concur with conditions; or nonconcur. The
meeting thereby identifies any issues to be resolved before or
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Chapter III The Regulation Development Process
during Red Border Review.
Red Border Review is the formal mechanism by which senior
management (usually Assistant and Regional Administrators and the
General Counsel) reviews and approves regulatory packages before
they are presented to the Administrator or other approving
official. The workgroup should already have defined all
significant issues and resolved all or most of them, so that no
new issues or problems arise during Red Border review.
Participation in the workgroup closure meeting is normally a
precondition for participation in Red Border—therefore, Red
Border review is conducted only by those offices that
participated in the development of the package by having a
representative on the workgroup.
When the workgroup process and the workgroup closure process
operate properly, Red Border is a relatively simple step which
formalizes the concurrence of other EPA offices and regions with
the rulemaking package. In some cases, however, problems or
issues are raised during Red Border which did not come up
previously, and can result in substantial additional efforts by
the workgroup to revise the package to meet the concerns of all
interested offices.
After Red Border Review is completed, the rulemaking package
is submitted for OMB review. Under Executive Order 12291, each
proposed and final rule which the agency issues must be sent to
the Office of Management and Budget (OMB) for review before it is
signed by the Administrator. The purpose of OMB review is to
assure that agencies choose from among various alternatives by
considering the costs and benefits associated with each.
The period for OMB review for major rules, established in
E.O. 12291, is 60 days for a proposed rule and 30 days for a
final rule; OMB can, however, extend this period when it needs
more time or when issues are unresolved. In virtually all cases,
rules do not go forward for final signature in EPA until the
program office addresses OMB concerns and resolves outstanding
issues. Court-ordered deadlines and stringent statutory
deadlines may occasionally require that EPA publish a rule before
OMB has finished its analysis and comment .
When OMB review is completed, the Federal Register notice is
sent to the Administrator for approval and signature. The
proposed rule is then published in the Federal Register, and the
See Chapter II of this guidance document for further discussion of E.O.
12291 and OMB review.
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Chapter III The Regulation Development Process
notice is distributed to interested parties. Publication of the
proposed rule is followed by a public comment period, typically
lasting 60 days, in which any interested party has the
opportunity to comment on the proposed rule or the supporting
analyses.
After the public comment period closes, the workgroup is
reconvened to review and respond to the public comments and to
prepare the final rule. The process for development of the final
rule is the same as for the proposed rule: analysis, workgroup
closure, Red Border, OMB review, Administrator's signature and
publication in the Federal Register.
B.
A number of major OPPT rulemakings for which RIAs are
prepared—particularly regulatory investigations under TSCA
Section 6—originate in OPPT's existing chemicals program. This
section discusses that program and the process by which Section 6
rulemaking candidates are identified. Exhibit III-l summarizes
the stages of the existing chemicals process and the outputs of
each stage.
1. Overview
Existing chemicals for which rules are developed and RIAs
prepared are identified after going through several preliminary
analytical steps in the OPPT Existing Chemicals Program. The
Existing Chemicals Program includes a variety of activities
involving assessment of risks and identification of possible risk
management activities for existing chemicals. The process is
designed to identify chemicals which may pose significant risks
to human health or the environment, to identify measures for
reducing those risks, and to seek implementation of the risk
reduction measures. Rule development is one of several possible
outcomes for any chemical evaluated in the existing chemical
process, and is initiated only after a number of analytical steps
have been completed.
The general framework for determining whether rulemaking or
other risk management activity should be initiated for any
particular chemical consists of two stages of analysis known as
RM1 and RM2. At both the RM1 stage and the RM2 stage,
information from a number of disciplines is developed and
integrated in order to assess the types of and magnitude of risk
to human health and the environment which may be posed by a
chemical, in order to determine whether risk management should be
pursued by OPPT.
16
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Exhibit III-l
Standard Products in the OPPT Existing Chemicals Process
Stage of Existing
Chemical Process
RIB Products
Other Technical
Products
OPPT Outputs
RM1
RM1 Economics Report
Chemistry Report
Engineering Report
Exposure Report
Hazard Review
RM1 Dossier
RM2
RM2 Economics Review
Chemistry Review
Engineering Review
Pollution Prevention
Analysis
Hazard Review
Exposure Review
Risk Review
RM2 Preliminary
Lifecycle and
Pollution Prevention
Assessment
Regulatory
Investigation
Use and Substitutes
Analysis
Economic Analysis
Risk Assessment
Risk of Substitutes
Analysis
Preliminary
Regulatory Decision
and Supporting
Analyses
Regulation
Development—
Proposed Rule
Preliminary
Regulatory Impact
Analysis
Economics sections of
Federal Register
Notice
Notice of Proposed
Rulemaking (Federal
Register Notice)
Regulation
Development—
Final Rule
Final Regulatory
Impact Analysis
Economics sections of
Federal Register
Notice
Notice of Final
Rulemaking (Federal
Register Notice)
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Chapter III The Regulation Development Process
When the RM2 stage of analysis is completed, the Office
Director may decide to pursue rulemaking for the chemical. A
regulatory investigation is then initiated, in which the detailed
analyses necessary to select a regulatory option and to support a
rule are developed. Once an option is selected for proposal, the
project enters the regulation development process. At this stage,
the Federal Register notice and the supporting documents will be
finalized, and the rulemaking package will go through the Agency
review process described above.
While processes for developing analyses and rules are
becoming increasingly standardized in OPPT, many portions of the
process tend to vary considerably by project. The following
descriptions capture, to the extent possible at this point, the
processes usually used for evaluating an existing chemical and
developing a regulation. Nevertheless, any individual project is
likely to have variations from the processes described here,
particularly in the regulatory investigation and regulation
development phase.
2. RM1
In the RM1 process, existing chemicals are reviewed to
determine if they pose potential risks of concern. The RM1
process involves reviews of available chemistry, economics,
engineering, exposure and hazard information by the appropriate
specialists in OPPT. These individual technical reviews are
integrated and summarized in an "RM1 dossier," prepared by the
RM1 project manager, which also contains recommendations for
follow-up actions. The dossier and its recommendations are
discussed at an RM1 Decision Meeting, usually attended by OPPT
Division Directors and staff.
The RM1 meeting determines which of the following actions to
take for the chemical under review: drop the chemical from
further consideration; develop more data for RM1 consideration;
take non-regulatory action such as asking industry to take
voluntary steps to address EPA's concerns; refer the chemical to
another federal agency; place the chemical on the Risk Reduction
List, which designates it for a more thorough review at the RM2
level; or obtain guidance from the Office Director by referring
the chemical for consideration at the Existing Chemicals
Management Meeting .
2See the RM1 guidance document for more information on RM1 and RIB's
involvement in the RM1 process: RIB How-to Guide: RM1 Economic Reports.
prepared for Libby Parker and Carol Rawie by MATHTECH Incorporated, July 1,
18
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Chapter III The Regulation Development Process
3. RM2
If there is a potentially significant concern for an RM1
chemical, it will then enter the RM2 process. In the RM2
process, OPPT develops information on the chemical to determine
if risk management is appropriate and to select the preferred
risk management path (e.g. regulation, voluntary agreement,
information dissemination, referral, etc.). The RM2 Preliminary
Lifecycle and Pollution Prevention Assessment examines the uses
and risks of a toxic substance throughout its lifecycle, and
identifies risk reduction opportunities. The RM2 assessment
incorporates information obtained through a Stakeholders'
Dialogue—i.e. discussions with parties such as chemical
producers and industrial users, environmental groups, and state
government agencies.
At RM2, it is determined whether a problem exists, what
solutions to the problem may exist, and what risk management path
is best for addressing the problem. A particular solution to the
problem is not necessarily selected at the RM2 stage.
4. Regulatory Investigation and Rule Development
When the RM2 process selects a regulatory path for risk
management, the rulemaking process is initiated. A Start Action
Request is submitted to the Steering Committee and an Agency
workgroup is formed.
For existing chemicals regulatory investigations, the
workgroup is usually under the leadership of a Project Manager,
who is responsible for coordinating the work of other workgroup
members, preparing the Federal Register notice which explains the
proposed rule, and conducting briefings of management on the
rule. The workgroup will usually include OPPT toxicologists,
exposure assessors, chemical engineers, risk assessors, and
economists, along with Office of General Counsel (OGC) lawyers
and representatives from the Office of Compliance Monitoring
(OCM) and the Office of Policy, Planning and Evaluation (OPPE).
Other EPA offices and EPA regions with an interest in the
rulemaking may also be represented on the workgroup.
The workgroup is responsible for carrying out the analyses
necessary to support a regulatory decision and a rulemaking,
including hazard assessment, exposure assessment, risk
assessment, use and substitutes analysis, and regulatory impact
1991.
19
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Chapter III The Regulation Development Process
analysis. In most cases, each of these substantive areas will
have been addressed in the RM1 and RM2 assessments, but more in-
depth work will be required to support rulemaking.
In contrast with the RM1 and RM2 stages of the existing
chemicals program, the regulatory development stage does not
currently have a standardized process or set of procedures.
There are, however, several standard work products produced by
OPPT which are required to support most existing chemical
rulemakings. A reasonable sequencing of events in the rule
development process for existing chemicals, which incorporates
these products, is as follows:
a. Decision to initiate regulatory investigation
As discussed above, this decision is usually made on the
basis of the RM2 Preliminary Lifecycle and Pollution Prevention
Assessment.
b. Preparation of the Use and Substitutes Analysis (RIB)
and Risk Assessment
A Use and Substitutes Analysis, prepared by RIB, contains
detailed market data on the chemical, including descriptions of:
the technologies, products and processes in which it is used; the
amounts used annually for each application; the available
substitutes; the methods by which the substitutes are used; and
the costs of using substitutes in place of the chemical of
concern. The use and substitutes analysis is a required input to
the cost analysis portion of the RIA . The Use and Substitutes
analysis also serves to identify chemicals which should be
evaluated in the Risk of Substitutes Analysis.
The risk assessment, prepared by the Chemical Screening and
Risk Assessment Division (CSRAD), combines information on the
chemical's hazard with information on exposure to the chemical to
characterize the aggregate level of risk to human health or the
environment. Preparation of the risk assessment is likely to
involve more detailed assessments of hazard, exposure and risk
than at the RM2 stage. The results of the risk assessment are
important for justifying any regulatory action, and are a
required input to the estimation of the benefits of regulatory
options.
See the Use and Substitutes guidance document (RIB How-To Guide: Use
and Substitutes Reports. August 1991) for discussion of U/S analysis and how
it is conducted. See also Appendix A of this document for a discussion of how
U/S data is used for cost estimation in RIB RIAs.
20
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Chapter III The Regulation Development Process
c. Preparation of the Economic Analysis (RIB) and Risk of
Substitutes Analysis
The purpose of the Economic Analysis, prepared by RIB, is to
provide the cost-benefit estimates of regulatory options
necessary to support a regulatory decision, and to provide
complete documentation of how these estimates were generated.
The Risk of Substitutes Analysis, prepared by CSRAD, is an
assessment of the risks of potential substitutes for the target
substance to support the determination of whether or not
regulation will actually reduce risk. The Risk of Substitutes
analysis is usually much less detailed than the Risk Assessment
of the substance to be regulated, particularly when there is
clearly a much lower hazard concern for the substitutes than for
the regulated substance. Where there are potentially significant
risks associated with the substitutes, the Risks of Substitutes
Analysis becomes an important input to the estimation of the
benefits of regulatory options .
d. Regulatory Decision
When the Use and Substitutes Analysis, Risk Assessment, Risk
of Substitutes Analysis and the Economic Analysis have been
completed, the project is ready for a decision on what option
should be proposed. At this point, the project manager and the
workgroup will prepare a briefing for the OPPT Office Director
and Division Directors explaining the results of the analysis.
In this meeting, the Office Director may select an option
for proposal, may ask that further analysis be done to better
support a regulatory decision, or may decide to drop the chemical
from further regulatory consideration. After the Office Director
selects an option for proposal, there will usually be a similar
briefing for the Assistant Administrator (AA) in which the AA
will be asked to concur with option selected by the Office
Director.
e. Preparation of the Federal Register Notice and the
Regulatory Impact Analysis (RIB)
After a regulatory decision to propose a particular option,
it is necessary to prepare a Federal Register notice and a
Regulatory Impact Analysis. The Federal Register (FR) notice
explains the proposed rule and supporting to the public. Drafts
See Appendix C for a discussion of how risks of substitutes enter into
the estimation of benefits.
21
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Chapter III The Regulation Development Process
of the notice are also a primary vehicle for communication of the
contents of the regulatory analysis and the proposed requirements
within OPPT and within the Agency. The FR notice discusses the
justification for the proposed rule, and discusses the
information which supports the legal requirements for
rulemaking - for example, the basis for the finding of
unreasonable risk under TSCA Section 6.
The Regulatory Impact Analysis is prepared by RIB following
a decision to develop a proposed rule. The purpose of the RIA,
as stated in OMB's RIA Guidance, is to "demonstrate that a
proposed regulatory action satisfies the requirements of Section
2 of Executive Order 12291. To do so, it should show that:
-There is adequate information concerning the need for and
consequences of the proposed action;
-The potential benefits to society outweigh the potential
costs; and
-Of all the alternative approaches to the given regulatory
objective, the proposed action will maximize net benefits to
society."
The RIA should therefore present the analysis which led to
the selection of the regulatory option which is being proposed,
and demonstrate that the proposal is supported by the analysis.
f. Completion of the Agency Regulation Development Process
After the FR notice and RIA have been completed and
approved, the rule continues with the Agency process described in
Section A of this chapter. This process includes workgroup
closure, Red Border Review, OMB Review, Administrator signature,
and publication in the Federal Register.
22
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CHAPTER IV
CONTENTS OF THE ECONOMIC ANALYSIS
A. Purpose of the Economic Analysis
An Economic Analysis of Regulatory Options develops and
presents the results of a cost-benefit analysis in order to
support a regulatory decision. The primary purpose of the
Economic Analysis is to develop information needed by OPPT
management on the costs and benefits of regulatory options for
making a regulatory decision. In addition, the Economic Analysis
provides much of the documentation necessary to support a
regulation and to allow evaluation of the cost and benefit
estimates by other parties, and is used as an input to the
preparation of a Regulatory Impact Analysis .
The Economic Analysis is prepared at the stage in a project
where OPPT management has identified a risk to human health or
the environment for which it expects to propose a regulation, but
before any regulatory approach has been selected. A model
outline for an Economic Analysis is shown in Exhibit IV-1.
In the Economic Analysis, a variety of regulatory options is
identified, and the costs and benefits of each option are
estimated. OPPT management uses these cost-benefit results as a
basis for selecting a regulatory option for proposal, or for
determining that regulation is not desirable.
The contents of the Economic Analysis are therefore focused
on identifying regulatory approaches, developing cost-benefit
estimates, and providing complete documentation for the cost-
benefit estimates—including thorough explanation of the
analytical methodologies and key assumptions; clear presentation
of the data used in the analysis and explanation of how they were
A Regulatory Impact Analysis (RIA) is the economic support document
prepared after a specific regulatory option has been selected, and presents
the economic rationale for a proposed or final rule, using the cost-benefit
results from the Economic Analysis. See Chapter VI of this guidance document
for discussion of the contents and preparation of an RIA.
23
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Chapter IV
Contents of the Economic Analysis
Exhibit IV-l
Economic Analysis Model Outline
Executive Summary
Chapter 1; Introduction
Chapter 2; Market Profile
2.1 Production
2.2 Uses
2.3 Substitutes
2.4 Existing Regulations
Chapter 3; Definition of the Problem and Regulatory Options
3.1 Risk Summary
3.2 Market Failure
3.3 Potential Need for Federal Regulation
3.4 Regulatory Options
Chapter 4; Costs of Regulatory Options
4.1 Methodology
4.2 Data
4.3 Sample calculations
4.4 Results
Chapter 5: Benefits of Regulatory Options
5.1 Methodology
5.2 Data
5.3 Sample calculations
5.4 Results
Chapter 6; Cost-Benefit Results
6.1 Methodology
6.2 Results
Chapter 7: Sensitivity Analysis
Chapter 8; Impacts of the Regulatory Options
8.1 Small entity impacts
8.2 Paperwork burden impacts
8.3 Trade impacts
8.4 Innovation impacts
8.5 Equity effects
References
Appendices
24
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Chapter IV Contents of the Economic Analysis
derived; and documentation of the calculations made to derive the
cost and benefit results.
The Economic Analysis should contain careful documentation
of the data and methodology used to develop cost and benefit
estimates, in order to ensure the soundness of the results which
are used in making a regulatory decision. In addition, thorough
documentation at this stage will reduce the effort required to
prepare the RIA, as the RIA will be able to provide more
summarized information while referencing the Economic Analysis
for details. The Economic Analysis is usually prepared by a RIB
contractor, under the close supervision of a RIB analyst, because
of the amount of effort required to perform all of the necessary
calculations and to document the analysis.
B. Section-by-Section Contents of the Economic Analysis
The following sections present a discussion of each of the
major topics included in the Model Outline for an Economic
Analysis (Exhibit IV-1).
Economic Analvsis~—Chapter 1; Introduction
This chapter briefly describes the problem under
consideration and the purpose of the report. It also discusses
the contents of the remainder of the report, by chapter.
Economic Analysis—Chapter 2; Market Profile
2.1—Production
2.2—Uses
2.3—Substitutes
2.4—Existing Regulations
This chapter summarizes the information presented in the Use
and Substitutes Report on the product being considered for
regulation and its market, including an overview of producers,
production volumes, uses, substitutes/competing products, and
existing regulations. Its purpose is to provide background for
understanding the risk of the substance, the options under
consideration, and the products and industries which would be
affected by the regulation. It does not need to be comprehensive
in its presentation of available data, as more detailed
presentation of data is found elsewhere in the report. If only a
certain use of the product is to be regulated, other uses should
still be addressed (how much consumption for the regulated use
25
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Chapter IV Contents of the Economic Analysis
relative to other uses; why the other uses are not being
considered in this regulation).
Economic Analysis—Chapter 3; Definition of the Problem and
Regulatory Options
3.1—Risk Summary
This section summarizes the findings of the Risk Assessment,
presenting a brief description of the risks which are the basis
for considering regulation. This section first summarizes the
hazard concern (the consequences of exposure to the substance,
i.e. the effects on human health or the environment, along with
any dose-response relationship or effects thresholds). This is
followed by a description of exposure to the substance—including
identification of the types of exposed populations (i.e., worker,
consumer, general population, or specific wildlife species), the
size of these populations, and the frequency, duration and levels
of exposure to each population. Hazard and exposure information
are then be combined in a discussion of risk, which describes the
estimated baseline health and environmental impacts, based on
what is known about hazard and exposure.
3.2—Market Failure
This section discusses of the market failure associated with
the risk. The discussion must identify a market failure
associated with the chemical being considered for regulation .
It is possible that there could be different market failures
associated with different types of exposures (e.g. occupational
vs. general population exposure) or different types of risk
(acute human health effects vs. chronic human health effects vs.
ecological effects).
This section then discusses the cause of each market
failure. Causes of market failure include: undefined,
improperly defined or misspecified property right systems (e.g.
negative externalities, common property resources and public
goods); divergence of private and social discount rates;
imperfect markets for trading property rights to resources
(information failure, monopoly, government intervention when none
was necessary, existence of government subsidies); and regulatory
A
According to economic theory, the benefits of regulatory intervention
can not be greater than the costs if there is no market failure.
26
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Chapter JV Contents of the Economic Analysis
failure (e.g. non-compliance with existing regulations or
statutes).
The purpose of this section is to provide an indication of
whether government action is necessary to address the problem,
and if so, the kind of action needed.
Both a risk and a market failure are necessary to
define the problem and to provide the justification for
considering regulatory options, as well as to provide
an indication of the types of regulatory options which
may be most appropriate.
3.3—Potential Need for Federal Regulation
This section explains why approaches other than Federal
regulation, such as regulation at the State or local level, or
nonregulatory Federal measures, would not address the market
failure adequately. See OMB's "Regulatory Impact Analysis
Guidance" in Appendix 6 for more discussion.
3.4—Regulatory Options
This section identifies the regulatory options to be
analyzed, and includes discussion of the application of four
general types of regulatory option to the problem being
considered:
labeling/information provision;
performance standards (i.e. numerical limits on
exposure levels or emissions levels);
bans and/or use restrictions; and
economic incentives.
For each type of option, specific approaches to be analyzed
in the RIA should be identified and discussed. In most cases,
there should be a relationship between the type(s) of market
failure(s) identified and the types of options analyzed. That
is, once the market failure is identified, there may be certain
types of regulatory options which appear to be best suited for
addressing that failure.
The workgroup for the project will usually play some role in
identifying and defining options to be addressed in the Economic
Analysis. Options to be analyzed in the Economic Analysis are
not limited to those identified by the workgroup. In many cases,
RIB will want to expand upon the workgroup's list of options by
evaluating varying levels of stringency for performance
27
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Chapter JV Contents of the Economic Analysis
standards, distinguishing among the different uses of a
substance, considering different effective dates, and considering
economic incentives.
When selecting options for analysis, the RIB analyst should
also include options which will have reduced impacts on small
entities, in order to anticipate the analytical requirements
imposed on proposed and final rules under the Regulatory
Flexibility Act .
If a particular type of option is not analyzed in the
Economic Analysis (for example, if no economic incentive options
will be analyzed), a justification for this exclusion should be
provided in this section.
Economic Analysis—Chapter 4; Costs of Regulatory Options
This chapter presents the methodology and data used in
estimating the costs of the regulatory options, along with the
costs results and sample calculations that demonstrate how the
results were derived. All costs to society should be estimated,
including direct compliance costs (i.e. the incremental costs of
implementing technologies which comply with the regulatory
requirements, such as the costs of equipment, labor, raw
materials, energy, etc.), administrative costs (e.g.
recordkeeping and reporting requirements), and costs to
government of implementing the rule . This chapter, along with
supporting appendices, should provide enough information so that
the reader can independently replicate the cost estimates.
The sections of the cost analysis chapter are as follows:
See Appendix F of this guidance document for further information on
compliance with the Regulatory Flexibility Act.
To estimate industry administrative costs and government costs of
implementing and enforcing the rule, input from the Office of Compliance
Monitoring (OCM) Toxics Enforcement Policy Branch (TEPB) is needed. OCM may
not have determined the compliance monitoring requirements at this stage of
the project. If detailed OCM input is not available, the report should
provide a "screening-level" indication of the expected magnitude of these
costs, with a qualitative assessment of whether or not any option would have
significant administrative and government costs, and whether or not there
would be any significant differences in these costs among the options. The
RIB analyst should work with OCM's workgroup representative to develop this
assessment.
28
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Chapter IV Contents of the Economic Analysis
4.1—Methodology for Cost Analysis
This section describes the methodology(s) to be used for
calculating costs of the regulatory options. It includes a
conceptual presentation of market responses to the different
types of regulatory options, illustrated with supply/demand
diagrams which show how the regulatory options result in changes
in consumer and producer surplus. The data needed to implement
the methodology should then be described, with reference to the
diagrams.
See Appendix A for discussion of a standard RIB cost
analysis methodology which combines economic theory with the
types of data usually available for RIB analyses of toxic
substance controls.
4.2—Data for Cost Analysis
This section presents the data to be used in calculating
the costs, according to the data needs identified in the previous
section. It should identify the sources of the data and discuss
the derivation of the estimates, including any important
assumptions. In many cases, it will be appropriate to reference
the Use and Substitutes report for explanations of data
derivation; it may also be useful to present the more detailed
information on the derivation of the data in an appendix to the
Economic Analysis. This section of Chapter 4 would then
summarize the results of the U/S report and/or appendix and
present the values for all parameters used in calculating the
costs of regulatory options. All data inputs to the cost
analysis should be summarized in tables.
4.3—Sample Cost Calculations
This section walks through the steps in calculating the
costs of a particular option, showing how the methodology and the
data are brought together to determine the costs of regulation.
With the presentation of the methodology and the data above,
along with this sample calculation, the reader should have been
given enough information so that he/she could calculate the costs
of any of the regulatory options and get the same results as
presented in the following section.
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Chapter IV Contents of the Economic Analysis
4.4—Results of the Cost Analysis
This section presents the cost results for each regulatory
option analyzed, and summarizes the results in tables. Exhibit
IV-2 presents a sample table of cost analysis results. The
results of the cost analysis should always be expressed in
present value and/or annualized terms (see Appendix B of this
guidance document for a discussion of discounting and
annualization). It may be useful to prepare an appendix of
tables or spreadsheets which show the calculations made for each
option, so that documentation is complete and clear. This also
gives the reviewers of the report the best opportunity to
determine whether the methodology has been properly implemented
and to check for math errors.
Economic Analysis—Chapter 5; Benefits ofRegulatory Options
This chapter presents the methodology and data used in
estimating the benefits of the regulatory options, along with the
benefits results and sample calculations that demonstrate how the
results were derived. The convention usually adopted for RIB
analyses is that only reductions in risks of human health and
environmental effects are included in the benefits side of the
analysis. Benefits to society of using the substance subject to
regulation are treated in the cost-benefit analysis as costs of
regulation, and are therefore the subject of the cost analysis
presented in Chapter 4 of the Economic Analysis. Furthermore,
any negative costs associated with a regulatory option are
included on the cost side of the analysis, and therefore should
not be counted in the benefits side of the analysis as positive
benefits.
Full documentation of models and procedures used for
calculating benefits must be presented either in this chapter or
in an appendix to the Economic Analysis. This documentation
should be sufficiently detailed to allow the reader to follow
through the calculations step-by-step and reproduce the benefits
results. Benefits which could not be quantified should also be
identified and discussed.
The extent of work required of RIB in calculating benefits
tends to vary from project-to-project; the amount and type of
description provided in the Economic Analysis depends on the
extent of work actually performed by RIB, and the extent to which
the calculation of cases avoided is documented in the Risk
Assessment.
30
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Chapter JV
Contents of the Economic Analysis
Exhibit IV-2
Sample Table of Cost Estimates
Annual Costs of Regulatory Options
Option
1 . Performance
Standard A
2 . Performance
Standard B
3 . Performance
Standard C
4. Ban Option A
5. Ban Option B
6. Ban Option C
7 . Incentive
Option A
8 . Incentive
Option B
Annual ized
Capital
Costs
($ Millions)
0
3
25
35
60
100
10
30
Annual
0 & M
Costs
($ Millions)
7
12
10
3
15
15
10
20
Total
Costs
Per Year
($ Millions)
7
15
35
38
75
115
20
50
Capital costs annual ized over the 15 -year life of equipment using a 7
percent private discount rate.
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Chapter IV Contents of the Economic Analysis
The following presentation assumes that RIB will be
responsible for all calculations of benefits. It therefore
includes sections which go into some detail regarding the use of
hazard and exposure data. In some projects, the Risk Assessment
will include calculation of baseline cases of effects, and/or of
cases avoided for certain regulatory options. In these
instances, it may not be necessary for RIB to perform
calculations in which dose-response estimates are combined with
exposure estimates to derive estimates of cases avoided, and RIB
documents will be able to reference the Risk Assessment instead
of presenting detailed documentation of the risk estimates.
The following presentation also assumes that there are no
risks to human health or the environment associated with the
substitutes. If there are meaningful risks associated with the
substitutes which can be quantified, information on the
calculation of these risks should be presented in the same format
as the information on the risks of the substance being considered
for regulation. The calculation of benefits of regulation should
then net out the risks of the substitutes, such that:
Benefits of = Value of - Value of avoiding
regulation avoided risks risks of substitutes
If the substitute risks can not be quantified, they should be
discussed qualitatively.
5.1—Methodology for Benefits Analysis
The purpose of the methodology section of the benefits
chapter is to describe the overall construct by which benefits
are calculated. It discusses the steps involved in the
calculation of benefits, which usually include:
1. Identify dose-response estimates or other data used to
quantify the incidence of effects
2. Estimate baseline exposure
3. Calculate baseline number of cases of each health effect
4. Estimate post-regulatory exposure for each regulatory option
A dose-response estimate is a value that quantifies the increased risk
of incidence of some health effect associated with a one-unit increase in
exposure to a toxic substance.
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Chapter IV Contents of the Economic Analysis
5. Calculate residual number of cases of each health effect
associated with each regulatory option
6. Calculate cases avoided of each health effect for each
regulatory option
7. Monetize the benefits: calculate benefits of each option in
terms of dollars
Appendix D of this guidance document contains further discussion
of the steps involved in benefits analysis.
5.2—Data
5.2.1—Effects and Dose-Response Estimates; This section
presents the dose-response relationships and/or effects
thresholds to be used in the calculation of benefits . Effects
for which benefits can not be quantified should also be discussed
in this section, with text emphasizing that these are real
benefits which should be considered in the decisionmaking, even
though they are not included in the benefits calculations. See
Exhibit IV-3 for a sample presentation of the effects considered
in a benefits analysis of a lead regulation.
5.2.2—Exposure Estimates; This section presents the exposure
parameters used to calculate benefits, including exposure levels
and size of population exposed to each level. Exposure data
should be presented separately for each exposed population (e.g.
different occupational groups, consumers of different products,
general population exposures from different media).
Data should be presented for baseline exposure (projected
exposure in the absence of new regulation) and for exposure
expected with each regulatory option. Depending on the option
and the expected market responses (determined in the Chapter 4
cost analysis), post-regulatory exposure may involve a reduction
in the exposure level, a reduction in the exposed population, or
a combination of these two impacts.
Information on the effects of the substance of concern and estimates of
any dose-response or thresholds should be available in the Risk Assessment.
The Risk Assessment is the starting point for the benefits analysis, as it
summarizes and integrates all information on hazard and exposure, presents
estimates of baseline risk, and characterizes the strength of the risk
estimates and any associated uncertainties.
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Chapter IV Contents of the Economic Analysis
Exhibit IV-3
Sample Exhibit for Presenting
Quantified and Non-Quantified Benefits Categories
Health Benefits Associated with Reduced Lead Exposure
Effects Quantified in the Benefits Analysis
Adult Males
Hypertension, ages 20-74
Non-fatal heart attack, ages 40-59
Non-fatal stroke, ages 45-74
Death, ages 40-54
Children (ages 0-7)
Reduced intelligence (lost IQ points)
Effects Not Quantified in the Benefits Analysis
Adult Males
Non-fatal heart attack, ages 20-39 and 59-74
Non-fatal stroke, ages 20-44
Death, ages 20-39 and 55-74
Adult Females (all ages)
Hypertension
- Heart attack
- Stroke
Death
Reproductive Effects
Children
Interference with growth
Interference with nervous system development
Impaired hearing
Behavioral changes
Metabolic effects, impaired heme synthesis, and anemia
34
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Chapter TV Contents of the Economic Analysis
In some cases, estimation of post-regulatory exposure will
be linked directly to the cost estimation methodology and
results. For example, a performance standard option may have the
direct effect of reducing the exposure level for a specific
population; however, if the costs of implementing the exposure
reduction are relatively high, there could be a reduction in the
use of the regulated substance as users switch to substitutes.
If the use of the target chemical goes down, it is likely that
the number of people exposed will go down proportionally. The
cost analysis will indicate the extent to which a regulatory
option affects the consumption of the target substance, and thus
becomes an input to the calculation of the post-regulatory
exposed population.
5.2.3—Valuation of Avoided Effects ("Monetizing" the Benefits);
For those quantified effects for which benefits can be expressed
in dollar terms, the methodology for valuing the effects avoided
should be discussed and values (e.g., dollars per case avoided)
presented. Whenever possible, benefits valuation should be based
on the concept of "willingness-to-pay." Willingness-to-pay
estimates are intended to encompass the full value of avoiding a
health or environmental effect. For human health effects, the
components of willingness-to-pay include the value of avoided
pain and suffering, impacts on the quality of life, costs of
medical treatment, and loss of income.
For some effects, the only benefits measures readily available
for use in an Economic Analysis will not represent estimates of
the full willingness-to-pay, but will instead capture only a
portion of benefits such as the avoided costs of medical
treatment. Whenever benefits are valued, the text should include
discussion of whether the benefits values are believed to be full
or partial measures of willingness-to-pay. See the EPA
Guidelines for Performing Regulatory Impact Analysis (Appendix A:
"Analysis of Benefits") for a discussion of methodologies used to
estimate values of avoiding human health and environmental
effects.
5.3—Sample benefits calculations
This section walks through the steps in calculating the
benefits of a particular option, showing how the methodology and
the data are brought together to determine the benefits of
regulation. With the presentation of the methodology and the
data above, along with this sample calculation, the reader should
have been given enough information so that he/she can calculate
the benefits of any of the regulatory options and get the same
results as presented in the following section.
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Chapter IV Contents of the Economic Analysis
5.4—Results of the benefits analysis
This section presents the benefits results for each
regulatory option analyzed. Benefits results should be
summarized in a table, expressed in present value and/or
annualized terms—so that they may be compared with the present
value and/or annualized costs calculated in Chapter 4. A sample
table of benefits results is shown in Exhibit IV-4. It may be
useful to prepare an appendix of tables or spreadsheets which
show the calculations made for each option, so that documentation
is complete and clear. This also gives the reviewers of the
report the best opportunity to determine whether the methodology
has been properly implemented and to check for math errors.
Economic Analysis—Chapter 6; Cost~Benefit Results
This chapter combines the results of the cost chapter and
the benefits chapter to help determine which option(s) are the
most desirable. In general, if benefits can be quantified and
valued, a net benefits analysis should be presented, in which the
cost of each option is subtracted from the benefits. A sample
table of net benefits estimates is shown in Exhibit IV-5.
The option which yields the greatest net benefits should
usually be the recommended option. When the unquantified factors
are significant, however, the option with the greatest calculated
net benefits may not be the most desirable policy. It is
therefore important that the net benefits analysis include
discussion of any costs and benefits which were identified in the
previous chapters but which could not be quantified.
If benefits can be quantified but not valued, a cost-
effectiveness analysis should be presented, in which the cost of
each option is divided by the quantified benefit. For example,
if benefits are quantified in terms of cases avoided of a single
health effect, cost-effectiveness analysis determines the cost
per case avoided for each option.
Cost-effectiveness analysis also allows for determinations
of which options are efficient (i.e. achieve given levels of risk
reduction at the least cost) and for analysis of the incremental
costs and benefits of regulatory options in comparison with one
another (i.e. a determination of the incremental cost per case
between two efficient options with different levels of risk
reduction). See Appendix E for a more detailed discussion of
cost-effectiveness analysis.
36
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Chapter IV
Contents of the Economic Analysis
Exhibit IV-4
Sample Table of Benefits Estimates
Annual Benefits of Regulatory Options
Option
1 . Performance
Standard A
2 . Performance
Standard B
3 . Performance
Standard C
4. Ban Option A
5. Ban Option B
6. Ban Option C
7 . Incentive
Option A
8 . Incentive
Option B
Annual
Benefits
to Children
($ Millions)
3
10
22
12
30
36
12
25
Annual
Benefits
to Adults2
($ Millions)
7
23
53
38
70
84
28
60
Total
Benefits
Per Year
($ Millions)
10
33
75
50
100
120
40
85
The following effects in children could not be quantified and are not
included in the benefits estimates: interference with growth; interference
with nervous system development; impaired hearing; behavioral changes;
metabolic effects; impaired heme synthesis; and anemia.
2Blood-pressure related effects could not be quantified for adult women and
for selected age -group ings of adult men, and are therefore not included in
the above benefits estimates. Similarly, reproductive effects in women
could not be quantified. See Exhibit IV- 3 for a complete listing of lead-
related effects which could and could not be quantified.
37
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Chapter JV
Contents of the Economic Analysis
Exhibit IV-5
Sample Table of Net Benefits Estimates
Annual Net Benefits of Regulatory Options1
Option
1 . Performance
Standard A
2 . Performance
Standard B
3 . Incentive
Option A
4. Ban Option A
5 . Performance
Standard C
6 . Incentive
Option B
7. Ban Option B
8. Ban Option C
Annual
Benefits '
($ Millions)
10
33
40
50
75
85
100
120
Annual
Costs
($ Millions)
7
12
20
38
35
50
75
115
Total
Net Benefits
Per Year
($ Millions)
3
21
20
12
40
35
25
5
Options are listed in order of increasing benefits.
2The following effects in children could not be quantified and are not
included in the benefits estimates: interference with growth; interference
with nervous system development; impaired hearing; behavioral changes;
metabolic effects; impaired heme synthesis; and anemia.
3Blood-pressure related effects could not be quantified for adult women and
for selected age -group ings of adult men, and are therefore not included in
the above benefits estimates. Similarly, reproductive effects in women
could not be quantified. See Exhibit IV- 3 for a complete listing of lead-
related effects which could and could not be quantified.
38
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Chapter IV Contents of the Economic Analysis
Economic Analysis—Chapter 7; Sensitivity Analysis
Sensitivity analysis is a re-analysis of the costs and
benefits of the regulatory options using different values for
parameters in the analysis which have a high level of uncertainty
or variability. Sensitivity analysis helps to determine whether
the uncertainty or variability is of significant concern for
policy making. For example, if there is uncertainty in the cost
of substitution when using a particular substitute, the cost
analysis in Chapter 3 and the Cost-Benefit Comparison in Chapter
5 may use a "best estimate." In the sensitivity analysis
section, the same analysis can be performed using upper bound and
lower bound estimates of the cost of substitution.
If the sensitivity analyses result in substantial changes in
the cost-benefit estimates, they could lead to a different policy
decision, or identify a need for more research to refine the
cost-of-substitution estimate. If, on the other hand, the
sensitivity analyses have cost-benefit results that are
essentially the same as the Chapter 5 analysis—i.e., the ranking
of the options in terms of net benefits or cost-effectiveness is
unchanged—this would indicate that the uncertainty is not
significant to the policy making process.
A separate sensitivity analysis should be presented in this
chapter for each input to the analysis for which there is
significant uncertainty or variability.
Economic Analysis—Chapter 8; Impacts of the Regulatory Options
Consideration of several types of "impacts analysis" can
frequently enter into a regulatory decision. These impact
analyses are concerned with the distribution of costs and the
types of costs incurred as a result of regulation, rather than
with the overall level of costs. Typical subjects for impacts
analysis include:
impacts on small entities;
paperwork burden on industry;
impacts on international trade;
impacts on technological innovation; and
equity effects.
Detailed analyses of impacts are intended to determine the
significance of the costs of regulation for any of the particular
categories of concern.
39
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Chapter IV Contents of the Economic Analysis
There may be variations in the level of impacts analysis
which is included at the Economic Analysis stage of a project.
Because the results of the impact analyses are not usually the
driving factor in the regulatory decision (cost-benefit
comparisons are usually more important), it will be desirable in
many cases to proceed with making a regulatory decision without
taking the time to complete a detailed quantitative evaluation of
potential impacts of each of the regulatory options.
At a minimum, however, the Economic Analysis should provide
a "screening-level" analysis of the impacts of the regulatory
options on small entities, paperwork burden, trade, innovation,
and equity effects. This evaluation should indicate whether the
likely impact of the regulatory options will be significant, and
whether there are significant differences in impacts among the
options. If significant impacts are identified, it may be
desirable to perform more detailed impacts analysis at this
stage . In some cases, however, it may be preferable to leave
more detailed analysis of impacts for the RIA stage of the
project, in the interest of moving to a Regulatory Decision more
quickly. This level of detail of the impacts analyses should be
determined on a case-by-case basis, in consultation with RIB
management.
Appendix P provides further information on the various types
of impacts analysis.
Economic Analysis—References
A single unified list of all references used in preparing
the analysis should be compiled and presented . References
should be cited throughout the document, with a complete list of
references numbered at the end. When the report is completed, it
will be necessary to assemble three complete sets of references:
two for delivery to the Information Management Division for the
public docket, and one to keep in your own project files as
If a screening-level analysis indicates that there may be significant
impacts associated with an option which appears to be a likely choice for
proposal, a more detailed analysis of impacts will probably be desirable. If
significant impacts are associated only with options that are undesirable for
other reasons--e.g., negative net benefits or high incremental costs per case
avoided--further impacts analysis would probably not be useful.
8At this stage in the project, copies of all references (including phone
logs) should also be compiled. Developing an organized set of references as
the report is being prepared will help avoid unnecessary and frustrating
efforts to track down the references at a later date.
40
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Chapter JV Contents of the Economic Analysis
backup. References have to be available in the docket for public
review during the proposed rule comment period so that they can
be examined by any interested parties.
The preferred style of referencing in the Economic Analysis
and the RIA is to use the author's name and the year in
parentheses in the text, as is done at the end of this sentence
(Smith, 1947). The reference list at the end of the report then
presents full bibliographic information, as shown in this
example:
REFERENCES
Smith, 1947. John Q. Smith, "Proper Referencing for OPPT
Technical Support Documents," Journal of Referencing. May
1947, pages 100-372.
Economic Analysis—Appendices
Appendices should be utilized to provide useful background
information and to provide documentation for the cost and benefit
estimates presented in the chapters.
41
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CHAPTER V
PREPARATION OF THE ECONOMIC ANALYSIS
Chapter IV of this document discussed the contents of an
Economic Analysis. In this chapter, guidance is presented on the
procedures to be used in developing an Economic Analysis. This
presentation of procedures assumes that the report follows the
model outline presented in Exhibit IV-1, which is reproduced here
as Exhibit v-1. The general approach presented in this chapter,
however, is applicable to any alternative report organization.
In general, the preparation of an Economic Analysis takes
place in three stages:
1. Planning Stage
2. Analysis Stage
3. Final Review Stage
While in practice there may be substantial overlap between the
three stages, it is useful for planning purposes to think of them
as three sequential phases of Economic Analysis preparation. The
following sections discuss the tasks completed in each stage.
A. Planning Stage
A.I Tasks Completed in the Planning Stage
The key tasks of the planning stage are to:
- Clearly define the problem (including: describe the
risk; identify the market failure)
Identify the options to be analyzed
Design the study and develop the analytical
methodologies
Identify the data needed and methods for filling any
data gaps
42
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Chapter V
Preparation of the Economic Analysis
Exhibit V-l
Economic Analysis Model Outline
Executive Summary
Chapter It Introduction
Chapter 2; Market Profile
2.1 Production
2.2 Uses
2.3 Substitutes
2.4 Existing Regulations
Chapter 3: Definition of the Problem and Regulatory Options
3.1 Risk Summary
3.2 Market Failure
3.3 Potential Need for Federal Regulation
3.4 Regulatory Options
Chapter 4: Costs of Regulatory Options
4.1 Methodology
4.2 Data
4.3 Sample calculations
4.4 Results
Chapter 5; Benefits of Regulatory Options
5.1 Methodology
5.2 Data
5.3 Sample calculations
5.4 Results
Chapter 6; Cost-Benefit Results
6.1 Methodology
6.2 Results
Chapter 7; Sensitivity Analysis
Chapter 8; Impacts of the Regulatory Options
8.1 Small business impacts
8.2 Paperwork burden impacts
8.3 Trade impacts
8.4 Innovation impacts
Equity effects
8.5
References
Appendices
43
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Chapter V Preparation of the Economic Analysis
Develop a report outline
Develop a schedule for producing the report
Develop an Economic Analysis Development Plan which
incorporates the outcome of each of the preceding tasks
Obtain management review and approval of the Economic
Analysis Development Plan.
In addition, tasks carried out during the Planning Stage
need to account for the iterative nature of decisionmaking. In
most projects, important changes need to be made in the analysis
when it is seemingly nearing completion. For example, as the
initial results of the analysis become known, OPPT management may
ask that new options be analyzed, or that key assumptions or data
be reconsidered. These later changes in direction can best be
handled if the methodology developed during the Planning Stage is
capable of quickly adapting to new options or new data.
A.2 Preparation of the Economic Analysis Development Plan
The mechanism for presenting the results of the Planning
Stage and for obtaining management review and approval is the
Economic Analysis Development Plan. A Development Plan is a
document which identifies the background for the economic
analysis, identifies the key issues which will be addressed by
the analysis, and discusses the methodologies which will be used
to address these issues.
The Economic Analysis Development Plan is a substantial
document which may require up to several weeks to complete,
depending on the complexity of the problem and the
availability of information. The Plan should be developed
jointly by the RIB analyst and tbe contractor, with the
input of RIB management and senior staff.
The contents of the Economic Analysis Development Plan are
shown in Exhibit V-2. Many of the sections of the Plan
correspond with particular sections of the Economic Analysis
itself discussed in Chapter IV of this document:
the Market Data Summary in the Plan corresponds to Chapter 2
of the Economic Analysis;
the Risk Summary. Market Failure, and Regulatory Options
sections in the Plan correspond to Chapter 3 of the Economic
Analysis;
44
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Chapter V Preparation of the Economic Analysis
Exhibit V-2
Contents of the
Economic Analysis Development Plan
1. Market Data Summary
2. Risk Summary
3. Market Failure
4. Regulatory Options
5. Cost Methodology and Data Needs
6. Benefits Methodology and Data Needs
7. Methodology for Cost-Benefit Comparison
8. Plan for Sensitivity Analysis
9. Plan for Impacts Analysis
10. Report Outline
11. Detailed Project Schedule
45
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Chapter V Preparation of the Economic Analysis
the Cost Methodology and Data Needs section corresponds to
Sections 4.1 and 4.2 of the Economic Analysis;
the Benefits Methodology and Data Needs section corresponds
to Section 5.1 and 5.2 of the Economic Analysis; and
the Methodology for Cost-Benefit Comparison section
corresponds to Section 6.1 of the Economic Analysis.
In addition, the Plan contains a preliminary assessment of
the expected contents and approaches to be taken in the
Sensitivity Analysis and Impacts of the Regulatory Options
chapters of the Economic Analysis .
The guidance for the corresponding sections of the Economic
Analysis, presented in Chapter IV of this document, should be
consulted when preparing these sections of the Economic Analysis
Development Plan. Each of these sections of the Development Plan
should be written so that it can be directly incorporated into
the draft Economic Analysis. This both helps to avoid
duplicative efforts, and helps to provide understanding of the
depth of presentation expected in the Development Plan.
In effect, the Development Plan is equivalent to a first
draft of the Economic Analysis/ containing only selected
sections of the report which create the foundation for the
report as a whole.
Preparation of a Development Plan allows for review of these key
sections of the analysis at an early point in the project
schedule, with the goal of improving the production of the
document as a whole and ensuring that the completed document will
meet the needs of the project, is methodologically sound, and is
well organized and documented.
It is also critical that the Development Plan contain an
outline of the projected report. Exhibit V-l is suggested as a
model for the report outline, however, the analyst should adapt
this model to the particular circumstances of a particular
project as needed. An outline must be included in the
Development Plan, however, so that reviewers of the plan can
receive a clear idea of how the separate portions of the analysis
are fit together.
These sections of the Development Plan should be as detailed as is
practical; however, in many cases it is difficult to be precise about
sensitivity analysis and impacts analysis until the cost and benefit analyses
are fairly well advanced.
46
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Chapter V Preparation of the Economic Analysis
Finally, the Development Plan must contain a schedule for
preparation of the report. The schedule should include several
distinct interim deliverables, allowing for review of initial
drafts of the separate sections of the report as they are
prepared. The schedule should also identify a reasonable
sequencing of the preparation of the sections of the report. An
example of such a schedule is shown in Exhibit V-3.
To complete many of the tasks involved in preparing the
Economic Analysis Development Plan, coordination will be
necessary with other workgroup members. Workgroup members will
often be important in developing descriptions and estimates of
risk, defining options to be analyzed, determining the
effectiveness of control options, and in developing the overall
project schedule.
Issues considered in the Planning Stage are not closed once
the Economic Analysis Development Plan is completed and the
Analysis Stage begins. As the project proceeds, new information
can change the approach to be taken in preparing the Economic
Analysis. As new information becomes available, the RIB Analyst
should be continually evaluating whether changes to the plan are
necessary and/or desirable.
B. Analysis stage
The key tasks of the Analysis Stage are to:
Complete data gathering/development and documentation
Prepare the computer programs or spreadsheets necessary
to do cost and benefit calculations
Calculate costs and benefits of options
Prepare report appendices which document the input data
and calculations used to derive cost and benefit
estimates
Prepare exhibits which summarize and/or illustrate the
methodology, data inputs, and results of the analysis
Prepare cost, benefit, and cost-benefit chapters of the
Economic Analysis
- Prepare screening-level impact analyses
Prepare the Economic Analysis report.
47
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Chapter V Preparation of the Economic Analysis
Exhibit V-3
Model Schedule for Preparation
of an Economic Analysis0
Milestone Due Date
Final Economic Analysis Development Plan Day 0
Final Chapter 2 (Market Profile) 4
Final Chapter 3 (Problem Definition/Options) 4
Draft Cost Appendices 18
RIB Comments to Contractor 20
Final Cost Appendices 25
Draft Chapter 4 (Cost Chapter) 31
RIB Comments 34
Final Chapter 4 38
Draft Benefits Appendices 48
RIB Comments 51
Final Benefits Appendices 54
Draft Chapter 5 (Benefits Chapter) 61
RIB Comments 65
Final Chapter 5 67
Draft Chapter 6 (Cost-Benefit Chapter) 69
RIB Comments 72
Memo: Plan for Sensitivity Analysis and Impacts Chapters 72
RIB Comments 74
Final Chapter 6 74
Draft Chapter 7 (Sensitivity Analysis Chapter) 79
RIB Comments 81
Final Chapter 7 83
Draft Chapter 8 (Impacts Chapter) 86
RIB Comments 89
Final Impacts Chapter 93
Draft Introduction (Chapter l) and Executive Summary 94
RIB Comments 96
Draft Report 100
RIB Management/Peer Review Comments to RIB Analyst 110
Compiled RIB Comments to Contractor 114
Workgroup Review Draft Report 121
Workgroup Comments to RIB Analyst 131
Compiled RIB Comments to Contractor 135
Draft Final Report 144
"Contractor deliverables are shown in bold.
bDrafts of Chapters 2 and 3 will have been contained in the Economic Analysis
Development Plan.
48
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Chapter V Preparation of the Economic Analysis
While most effort in the Analysis Stage should not be
initiated until completion of the Planning Stage, some limited
efforts may be desirable—for example, work on filling specific
data gaps which are crucial to the analysis can be done
concurrently with development of the Economic Analysis
Development Plan. In some cases, the Development Plan may be
greatly improved with the addition of a relatively small amount
of data gathering. In general, however, efforts in the Analysis
Stage should be relatively limited until the Planning Stage is
completed, because it is in the Planning Stage that activities to
be undertaken in the Analysis Stage are identified and defined.
Work in the Analysis Stage should also be carried out in a
cooperative, interactive process between the RIB analyst and the
contractor. As the contractor completes data gathering, the RIB
analyst should review and approve the data gathered and any
assumptions to be used to fill any data gaps. As the analysis
proceeds, the contractor should prepare draft appendices and
chapters of the report which document the methodology, data and
results of the analysis.
The recommended approach for documenting the analysis and
compiling the report is to:
First, prepare appendices to the report which document the
details of the analysis and the derivation of the results ;
Second, prepare exhibits which summarize the key information
used in the analysis should be prepared; and
Third, prepare the text of the main chapter making reference
to the relevant exhibits and appendices.
These steps can be followed separately for every main
subject of analysis. For example, you may want to first prepare
the appendices, exhibits and text for the cost chapter, then
prepare the appendices, exhibits and text for the benefits
chapter. This approach is reflected in the sample schedule shown
in Exhibit V-3.
The draft appendices, exhibits and chapters should be
carefully reviewed by the RIB analyst to make sure that it is
clear how the analysis has been conducted, that all important
assumptions have been explained and are reasonable, and that
The draft RIA for Urea-Formaldehyde Pressed Wood makes extensive use of
appendices in this manner and should be consulted as a model.
49
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Chapter V Preparation of the Economic Analysis
there are no errors in the calculations. This careful review
also gives the RIB analyst sufficient understanding and knowledge
of the analysis to be able to effectively brief the workgroup and
management.
The RIB analyst should notify RIB management of any
significant problems with any of the draft materials, and should
feel free to consult with management or senior staff to help
evaluate the progress and quality of the contractor's work. It
is important that any significant problems or questions be
addressed at an early point in the project, rather than waiting
for the complete report to be assembled. This early
identification will allow for the necessary adjustments to be
made before significant amounts of effort and time are wasted in
going in the wrong direction.
During the Analysis Stage, the RIB analyst and the
contractor should also be considering whether any changes in the
Development Plan are needed. Necessary changes in the
methodology, the options analyzed or the schedule may become
apparent as the work proceeds.
C. Final Review stage
The Final Review Stage begins when a completed report,
comprised of the individual chapters which have been prepared and
reviewed in the Analysis Stage, is compiled. There should be
three levels of review and revision in this stage:
- RIB analyst review of the complete report
RIB management/senior staff review
- Workgroup review
It is important that adequate time be planned into the
project schedule to allow for review of the completed report.
For each of the last two stages of review, two weeks should be
allowed for review of the report and two weeks to make revisions
to the report. If the Economic Analysis has been well-planned,
and if problems are properly identified and addressed in the
analysis stage, less time will be required to revise the report
in the review stage. Nevertheless, it is important to allow for
the possibility that problems or new options will arise at this
stage by scheduling in time for report revisions.
In addition, further iterations of the report may be
required beyond the workgroup review stage. For example, OPPT
management may feel that more analysis is needed before a
decision can be made—new options may be inserted into the
50
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Chapter V Preparation of the Economic Analysis
analysis, or key assumptions may be reevaluated, for example.
Even after the regulatory decision, further revisions to the
Economic Analysis may be needed in order to insure that it
provides all the documentation needed to support the RIA.
D. Outline of Steps in Preparing an Economic Analysis
The steps outlined below provide a rough guide to the
sequencing of activities involved in preparing an Economic
Analysis. The actual definition of tasks and ordering of tasks
for any particular project should be prepared during the Planning
Stage and presented in the "Schedule" section of the Economic
Analysis Development Plan.
This outline of the Economic Analysis development process
stresses that as work proceeds, the RIB analyst should constantly
be reevaluating the work done previously to see if new data or
results suggest changes or improvements that can be made or new
issues which should be incorporated.
Planning Stage
1. Assemble and review existing documents, including RM1 and
RM2 packages, the Use and Substitutes Analysis, the Risk
Assessment, and any other key workgroup documents.
2. Define the problem, including:
-the substance (or product) and its production/uses
-existing regulations
-hazard concerns
-exposed populations and exposure levels
-risk estimates
-market failure
3. Identify potential solutions; select options for analysis
-labeling/public information options
-performance standard options
-ban/use restriction options
-economic incentive options
4. Develop outline for Economic Analysis
5. Develop methodologies for analysis
-cost analysis methodology
-benefit analysis methodology
-cost-benefit comparison methodology
51
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Chapter V Preparation of the Economic Analysis
6. Identify data needs
-cost data
-benefits data
7. Identify and evaluate data already available (where it is,
what it is, how good it is)
-cost data
-benefits data
8. Identify data collection needs and methods (what data are
needed, how they will be obtained/developed)
-cost data
-benefits data
9. Identify issues/data inputs for sensitivity analysis.
10. Evaluate need for and level of impact analyses (e.g. small
business, trade); develop methodology and identify data
gaps.
11. Develop project schedule
12. Prepare Economic Analysis Development Plan, presenting the
results of the above steps
13. Obtain review of the Development Plan by RIB management
and/or senior staff. Revise Plan to address comments and
suggestions.
Analysis Stage
14. Complete data collection
15. Re-evaluate options, methodology and data needs in Economic
Analysis Development Plan in light of new data;
repeat/revise above steps to the extent necessary; prepare
report introduction
16. Prepare Cost Analysis
-Calculate costs
-Prepare draft cost appendices
-Prepare draft cost exhibits
-Prepare draft cost chapter
-Review and revise draft cost appendices and chapter
52
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Chapter V Preparation of the Economic Analysis
17. Prepare Benefits Analysis
-Calculate benefits
-Prepare draft benefits appendices
-Prepare draft benefits exhibits
-Prepare draft benefits chapter
-Review and revise draft benefits appendices and chapter
18. Prepare Cost-Benefit Comparison
-Calculate net benefits and/or cost-effectiveness
-Prepare draft cost-benefit exhibits
-Prepare draft cost-benefit chapter
-Review and revise draft cost-benefit chapter
19. Prepare Sensitivity Analysis
-Select alternate parameter values
-Calculate new cost-benefit results
-Prepare draft sensitivity analysis exhibits
-Prepare draft sensitivity analysis chapter
-Review and revise sensitivity analysis chapter
2 0. Prepare Impact Analyses
-Develop screening-level estimates of impacts
-Prepare draft impacts analysis exhibits and chapter
-Review and revise impact analysis chapter
Final Review Stage
21. Assemble complete draft report; review and revise draft
report.
22. Submit draft report for RIB Management Review/Peer Review.
Revise report to respond to comments.
23. Submit draft report for Workgroup Review. Revise report to
respond to comments. Make further revisions as needed until
Regulatory Decision is made.
24. Assemble complete set of Economic Analysis references—
including copies of articles, books (relevant
pages/chapters) and product literature used as well as phone
logs/meeting notes for any personal contacts cited .
25. Regulatory Decision >begin preparation of RIA (see Chapter
VI of this guidance document for details).
Copies of references should be well organized and correspond to the
reference list in the Economic Analysis, so that there are no problems when
references are submitted to IHD for placement in the docket.
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Chapter V Preparation of the Economic Analysis
E. Role of the RIB Contractor in Preparing an Economic Analysis
The Economic Analysis is usually prepared by a RIB
contractor for the RIB analyst. The contractor is usually
responsible for gathering the data, performing the calculations
necessary in the analysis, and preparing the report. The RIB
analyst is responsible for defining the scope and content of the
report, for coordinating any issues requiring interaction between
the Economic Analysis and any other workgroup outputs, and for
reviewing the contractor's work. More specific responsibilities
of the RIB analyst include:
Make decisions regarding the scope of the economic analysis
and the options to be evaluated, keeping in mind the
anticipated response of OMB to the regulation, the budget
for the project, and the time constraints;
Provide the contractor with all relevant information
received or developed by EPA, such as technical studies and
reports, results of data collection efforts, and field
information;
Ensure that data used in the RIA is consistent with that
used in the Risk Assessment, the Use and Substitutes
Analysis, or other EPA analyses;
- Advise the contractor of the results of work group meetings,
including regulatory options being considered, concerns or
comments of the work group members, etc.;
Communicate results from the Economic Analysis back to the
work group.
The RIB analyst is ultimately responsible for the entire
contents of the Economic Analysis, and should therefore not
only be familiar with the contents of the report, but should
be in agreement with the methodological approach as well as
the data used and the critical assumptions made, and should
understand bow all results were derived.
In practice, Economic Analysis development tends to be most
successful when the RIB analyst and the contractor staff work
together closely as a team, with joint development of the
analytical methodology and scope of analysis, as well as frequent
communication on the direction and progress of the project and
discussion of problems as they arise.
54
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CHAPTER VI
CONTENTS AND PREPARATION OF THE REGULATORY IMPACT ANALYSIS
A. Purpose of the RIA and Differences Between the Economic
Analysis and the RIA
After the decision to develop a proposed regulation is made
(see Chapter III), a Regulatory Impact Analysis is prepared. The
purpose of the RIA is to demonstrate to the Office of Management
and Budget (OMB) that the rulemaking complies with the
requirements of Executive Order 12291. As stated in OMB's
"Regulatory Impact Analysis Guidance," an RIA should:
demonstrate that a proposed regulatory action
satisfies the requirements of Section 2 of
Executive Order 12291. To do so, it should show
that:
There is adequate information concerning
the need for and consequences of the
proposed action;
The potential benefits to society
outweigh the potential costs; and
- Of all the alternative approaches to the
given regulatory objective, the proposed
action will maximize net benefits to
society.
The RIA therefore is a document which presents the Agency's
rationale for the specific proposed regulatory requirements,
drawing from the cost-benefit estimates contained in the Economic
Analysis. The RIA presents the analysis which led to the
selection of the regulatory option which is being proposed, and
demonstrates that the proposal is supported by the analysis.
As discussed in Chapter II, the requirements of Executive
Order 12291 are similar to requirements for TSCA Section 6
rulemaking such as the required finding of "unreasonable risk"
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Chapter VI Contents and Preparation of the RIA
and the requirement to select the least burdensome alternative
which adequately reduces the risk. Therefore, there should not
be any difficulty in demonstrating in an RIA that a Section 6
proposal or final rule meets the requirements of E.O. 12291.
The RIA differs from the Economic Analysis in that it
contains more general presentations of the analytical
methodology, the derivation of the data, and the derivation of
the cost and benefit estimates. The RIA focuses on "telling the
story" of the analysis which brought the Agency to the policy
conclusions driving the proposed or final rule, and serves as a
policy advocacy document. The Economic Analysis, as discussed in
the preceding chapters, is focused more on documentation of the
analysis and providing information for use in deciding which
regulatory option, if any, should be proposed.
After the RIA has been prepared, the Economic Analysis still
exists as a resource for readers of the RIA who want more details
on how the analysis was conducted and where the data in the
analysis came from. As a result, the RIA is able to focus more
on the "big picture" issues, presenting information in a more
summarized fashion that emphasizes on the policy conclusions and
the analytical results that support them, with less emphasis on
the means by which the analytical results were generated.
In addition, the RIA should present the analyses of the
"impacts" of the proposed rule. In most cases, these analyses
are intended to address the impacts of the regulatory option
being proposed—e.g., its impacts on small entities (Regulatory
Flexibility Analysis), trade, innovation, paperwork reporting
burdens (under the Paperwork Reduction Act), and its
distributional impacts (i.e. equity effects).
While these impacts should usually be addressed in the
Economic Analysis, the analysis included there may be only a
"screening-level" analysis which provides only a qualitative
evaluation of the impacts of different options. In the RIA, the
results of a more detailed and quantitative analysis of the
impacts of the proposed rule requirements will be presented.
B. Contents of the RIA
The primary audience for the RIA is OMB, since the purpose
of the RIA is to demonstrate to OMB that the rulemaking meets the
requirements of E.O. 12291. OMB's "Regulatory Impact Analysis
Guidance" (contained in Appendix 6 of this document) identifies
five elements which should be contained in any RIA. These are:
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Chapter VJ Contents and Preparation of the RIA
1. A statement of the potential need for the proposal,
including demonstration that "(a) market failure exists
that is (b) not adequately resolved by measures other
than Federal regulation."
2. An examination of alternative approaches.
3. An analysis of benefits and costs.
4. The rationale for choosing the proposed regulatory
action.
5. A statement of statutory authority.
Each of these elements is incorporated into the Model RIA
Outline shown in Exhibit VI-1 and into the following discussion
of the standard contents of an RIA. The following discussion
does not go into detail on the contents of each chapter in the
RIA and the underlying analytical considerations, as these are
addressed at the Economic Analysis stage of the project and in
Chapter IV and the appendices of this guidance document.
RIA—-Chapter 1: Introduction
This chapter describes the provisions of the rule being
proposed, the statutory authority under which the rule is being
proposed, and the purpose and contents of the report.
RIA Chapter 2: Market Profile
This chapter should reproduce the information presented in
the corresponding chapter of the Economic Analysis. It can,
however, incorporate more up-to-date information or additional
data if any is available that improves upon the previous version.
As in the Economic Analysis, the purpose of this chapter is to
provide general background information on the product being
regulated, its producers, and its uses, in order to provide
context for the definition of the problem and the regulatory
options in the following chapter.
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Chapter VI Contents and Preparation of the RIA
Exhibit VI-1
Regulatory Impact Analysis Model Outline
Executive Summary
Chapter 1: Introduction
Chapter 2: Market Profile
2.1 Production
2.2 Uses
2.3 Substitutes
2.4 Existing Regulations
Chapter 3; Definition of the Problem and Regulatory Options
3.1 Risk Summary
3.2 Market Failure
3.3 Potential Need for Federal Regulation
3.4 Regulatory Options
Chapter 4; Costs of Regulatory Options
4.1 Methodology summary
4.2 Data summary
4.3 Results
Chapter 5; Benefits of Regulatory Options
5.1 Methodology summary
5.2 Data summary
5.3 Results
Chapter 6; Cost-Benefit Results
Chapter 7; Sensitivity Analysis
Chapter 8; Impacts of the Proposed Rule
8.1 Regulatory Flexibility Analysis
8.2 Paperwork Reduction Act Analysis
8.3 Trade Impacts Analysis
8.4 Innovation Impacts Analysis
8.5 Equity Effects Analysis
Chapter 9; Rationale for the Proposed Rule
References
58
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Chapter VI Contents and Preparation of the RIA
RIA—Chapter 3; Definition of the Problem and Regulatory Options
This chapter should reproduce the information presented in
the corresponding chapter of the Economic Analysis. The
definition of the problem is a critical section of the RIA which
is specifically asked for in OMB's RIA guidelines. This section
should be as detailed as possible because it is an important
element in justifying regulatory intervention.
The description of regulatory options is also important for
providing background for the remainder of the document, and
should therefore also not be any less detailed than the
presentation in the Economic Analysis. It may, in fact, need to
be more detailed in cataloguing the number of different ways in
which a regulatory approach could be modified and in
discussing/justifying whether or not the modifications were
considered in the analysis, since OMB's guidance stresses
consideration of these issues. See Chapter IV of this guidance
document and OMB's "Regulatory Impact Analysis Guidance" for more
discussion.
RIA—Chapter 4; Costs of Regulatory Options
The purpose of this chapter is to briefly describe the
analytical methodology for developing the cost estimates, present
the data used to implement the methodology, and the cost
estimates themselves. The reader should be referred to the
Economic Analysis for a more detailed presentation of the
methodology, derivation of the input data, sample calculations,
and documentation of the cost results. All social costs,
including industry administrative costs and government
implementation and enforcement costs should be included at this
stage .
RIA—Chapter 5; Benefits of Regulatory Options
This chapter briefly describes the analytical methodology
for developing the benefit estimates, presents the data used to
implement the methodology, and presents the benefit estimates
In many cases, it will not have been practical to include a thorough
analysis of government costs and administrative costs to industry (e.g.
recordkeeping, reporting) in Chapter 4 of the Economic Analysis. Additional
analysis and documentation beyond that contained in the Economic Analysis will
therefore be necessary.
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Chapter VI Contents and Preparation of the RIA
themselves. The reader should be referred to the Economic
Analysis for a more detailed presentation of the methodology,
derivation of the input data, sample calculations, and
documentation of the benefit results. Benefits which could not
be quantified should be identified and discussed.
RIA—Chapter 6: Cost-Benefit Results
This chapter presents cost-benefit comparisons for all of
the options in the form of either net benefits estimates or cost-
effectiveness analysis. Since this will have been a relatively
brief section of the Economic Analysis, it can probably be
reproduced in whole in the RIA.
RIA—Chapter 7: Sensitivity Analysis
This chapter should summarize the sensitivity analysis
inputs and results, and refer the reader to the Economic Analysis
for details.
RIA—Chapter 8: Impacts of the Proposed Rule
This chapter presents analyses of several possible impacts
of the proposed rule provisions. These analyses should include
quantitative results wherever possible and should be focused
specifically on the requirements of the proposed rule, although
for some of these analyses it may also be useful or necessary to
address the impacts of alternative regulatory options . The
analyses which should be presented in this chapter include:
Regulatory Flexibility Analysis (analysis of impacts on
small entities);
- Paperwork Reduction Act Analysis;
Trade Impacts Analysis;
- Analysis of Impacts on Technological Innovation; and
Equity Effects Analysis.
Appendix F presents further discussion of these analyses.
In order to present the results of these analyses, additional analysis
and documentation, beyond that contained in Chapter 8 of the Economic Analysis
(as described in Chapter IV of this guidance document), may be necessary.
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Chapter VI Contents and Preparation of the RIA
RIA Chapter 9—Rationale for the Proposed Rule
This chapter should present the Agency's rationale for the
proposed regulatory requirements. Since the purpose of the RIA
as a whole is to present this rationale, this chapter should
primarily summarize and integrate the major points made in the
preceding chapters which support EPA's policy decision.
c. Preparation of the RIA
Once the regulatory decision is made, the RIB analyst should
develop a plan for preparation of the RIA. In most cases the
content and preparation of this plan will be similar to the
Economic Analysis Development Plan discussed in Chapter IV of
this guidance document, but will not need to be as detailed. It
should, however, identify any additional analytical tasks
required for completion of the RIA, discuss how these tasks will
be completed, and present an outline of the RIA and a schedule
for production of the RIA. The identification of tasks should
highlight any products required from other workgroup members
which are necessary for the completion of the RIA, and the
schedule should be coordinated with the workgroup. This Plan
should be submitted to the RIB Branch Chief for review and
approval.
The RIA itself is prepared primarily by the RIB analyst,
because its purpose is to support a particular policy decision.
Contractor support is available when revised analytical results
are needed (e.g., analysis of an additional option, change in an
assumption in the analysis), and if any new analyses need to be
prepared (e.g., estimation of paperwork burden hours, estimation
of government costs, estimation of trade impacts).
In addition, certain portions of the RIA with less policy
content, such as the summary of the cost analysis, may be
prepared by the contractor if necessary to economize on the RIB
analyst's time. The RIA should be a much shorter document than
the Economic Analysis, because the RIA is focused on presentation
of the key information which supports a proposed/final
regulation, and because it can reference the Economic Analysis
for details.
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APPENDIX A
USING DERIVED STEP-DEMAND FUNCTIONS TO
ESTIMATE THE COSTS OF REGULATORY OPTIONS
Costs of regulatory options in most economic analyses
prepared by RIB are estimated using direct costs estimates of the
measures taken to comply with a regulatory option. For example,
costs of direct regulatory control options, such as those
considered under TSCA Section 6, are frequently estimated by
determining the costs of engineering controls to prevent human
exposure or environmental release, or by determining the cost of
using substitutes for the substance to be regulated.
This appendix describes an economic framework, based on
stepped demand functions, which makes direct use of engineering
control costs and substitution costs. This framework has been
used in several previous RIB analyses, and is useful for
assessment of regulatory options under which substitution for the
controlled substance is expected (e.g. many TSCA Section 6
options), because it integrates the principles of economics with
the engineering cost estimates frequently used in RIAs . Other
approaches, however, may also be appropriate; the analyst is free
to consider the advantages and disadvantages of this methodology
relative to other approaches when preparing the Economic Analysis
Development Plan (see Chapters IV and V).
1. The Step-Demand Function Framework
Before this integrated framework is presented, first
consider a textbook-style presentation of the costs of a
regulation. Exhibit A-l shows the supply and demand curves for a
product to be regulated. To simplify the presentation, the
The methodology presented in this chapter is probably not appropriate
for analysis of information-gathering requirements, as the costs of such
requirements are usually too small to induce any substitution.
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Exhibit A-1
Conventional Supply and Demand Framework
a
Q
Exhibit A-2
Regulatory Costs in the Conventional Framework
1 1 •
p_ _
ro
a
•^— o
f^^b
X. °
^D
Q
-------
Appendix A Using Derived Step-Demand Functions
supply curve is horizontal . The costs of a ban of this product
would equal area abc—the entire amount of consumer surplus
derived from this product.
Exhibit A-2 shows the impact of a regulation which requires
a reduction in emissions. To comply with the regulation,
producers could install engineering controls—which increases the
cost of supplying the product. Supply therefore shifts up from B
to 8'. The increased cost of supply results in a decreased
quantity demanded (from Q0 to Qj) .
The costs of the regulation in this example are equal to
area abed—the total loss in consumer surplus. This area has two
components: one which represents the increased cost of producing
quantity Q1 due to the engineering controls (afed), and one which
represents the lost consumer surplus associated with quantity (Q0
- Q,) which is no longer consumed (fbe).
The difficulty for RIB analyses is that we rarely have
sufficient data to allow econometric estimation of demand curves.
Instead of the type of smooth, continuous demand curve shown in
Exhibits A-l and A-2, we frequently develop derived step-demand
curves of the type shown in Exhibit A-3.
This step-demand curve is derived from data developed in a
Use and Substitutes Analysis, with each step corresponding to a
different substitute for the regulated product (Product X). The
height of each step is equal to the cost of using a particular
substitute in place of Product X. The height of each step
therefore shows the cost of Product X at which consumers would be
indifferent between Product X and that substitute.
The width of each step in the step-demand curve represents
the portion of the market for Product X which could be replaced
by that substitute. The width therefore represents a market
share projection—the maximum amount of the Product X market
which could be taken by that substitute.
2
In many RIB analyses, it is reasonable to assume that the long-run
supply curve is horizontal. A good's long-run supply curve is horizontal when
changes in the quantity supplied of that good do not cause changes in the
costs of the inputs employed in producing that good. In most cases,
implementation of a regulatory option will not cause changes in the total
demand for inputs (labor, equipment, energy, raw materials) large enough to
result in changes in their costs. The shape of the supply curve should be
evaluated on a case-by-case basis.
64
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Exhibit A-3
The Step-Demand Framework
P3-
.1. .......
......... r.
Pol 1 S
D
Q3 Q2 QI QQ U
Exhibit A-4
Regulatory Costs in the Step-Demand Framework
With No Substitution
P
P4
PS-I
P2-i
PA ^x\xxx\\xxN\x\\xxxxx\x\xxv|C S'
P0[f^^^^^ S
. JD
Q3 Q2 O- O« >J
-------
Appendix A Using Derived Step-Demand Functions
This type of demand curve can be used in evaluating
virtually any type of regulatory control option. Consider first
a ban on Product X. As above, the cost of the ban is the
reduction in consumer surplus—that is, the area between the
demand curve and the supply curve. In physical terms, this is
equal to the increased costs incurred due to the use of each
substitute in place of Product X for a particular share of the
Product X market. Therefore, with four steps in the demand curve
in Exhibit A-3, total costs are determined by a four separate
calculations of
[(cost of substitution for Product X) x (quantity of Product
X replaced)].
For example, the cost corresponding to the first step is
[ (P, - P0) x (Q0 - Qn)]. A similar calculation would be made for
each of the other three steps; the cost for all four steps would
be added together to determine the total direct compliance costs
of the ban .
Engineering controls, or any other requirement which
increases the cost of producing or using Product X can also be
analyzed using this framework. Any increase in costs for Product
X is modeled by shifting up the supply curve—for example, an
engineering control costing $100,000 per year in a plant
producing 1,000,000 units per year would shift up the supply
curve by $0.10 per unit. As in the textbook-style analysis, the
post-regulation price and quantity are determined by the
intersection of the supply and demand curve.
In Exhibit A-4, the new supply curve intersects the demand
curve below P1—so there is no change in the original quantity
Q0. In this case, the unit costs of the engineering controls are
lower than the unit cost of substitution for all substitutes—
therefore, no substitution takes place, the original quantity of
Product X is unchanged, and all Product X is produced with the
required engineering controls. The total cost of the regulation
is therefore equal to the unit cost of the control times the
original quantity of Product X—area abed in Exhibit A-4.
This methodology would not usually take into account other costs
associated with the regulatory option, such as industry administrative costs
(e.g. recordkeeping and reporting) and government implementation costs. These
costs should be calculated separately.
66
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Appendix A Using Derived Step-Demand Functions
In Exhibit A-5, the cost increase associated with the
engineering controls is greater, so that the new supply curve
intersects the demand curve at a price greater than P.. Because
it costs less to use Substitute 1 than to continue using Product
X, the portion of the market which can use Substitute 1 makes
this switch. The quantity demanded of Product X therefore falls
from Q0 to Qv The quantity does not fall any further because:
1. Substitute 1 has been estimated to have a maximum
replacement market share of Q0 - Q^j and
2. The other three substitutes each have a unit cost of
substitution greater than the unit costs of the
engineering control.
Therefore, the costs of this regulatory option are:
[(the incremental unit cost of engineering controls) x
(the post-regulation quantity of Product X)] +
[(the incremental unit cost of substitute 1) x (the
quantity substituted)]
which is equal to:
[(PB - P0) x (Q,)] + [(P, - P0) x (Q0 - Q,)].
This is indicated as area abfg plus area bcde in Exhibit A-5.
The same approach applies to greater shifts in the supply
curve. For example, if the post-regulation supply curve
intersects the demand curve at a price greater than P2 but less
than P3, a second segment (Q, - Q2) of the Product X market would
shift to a substitute, at a cost of P2; and the post-regulation
quantity demanded of Product X would be Q2. The costs of the
regulation would therefore equal area cdef (Substitute 1) plus
area bcgh (Substitute 2) plus area abjk (engineering controls) in
Exhibit A-6.
Note that this methodology implicitly assumes that the
collective demand for Product X and its substitutes is perfectly
inelastic. That is, even if Product X is removed from the market
and consumers bear higher costs in using its substitutes, the
quantity of substitutes consumed after the regulation is equal to
the quantity of Product X which would have been consumed in the
absence of regulation. In effect, demand for the function
provided by Product X is perfectly inelastic with respect to the
increased cost of the substitutes.
67
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Exhibit A-5
Regulatory Costs in the Step-Demand Framework
With Partial Substitution
Q
Exhibit A-6
Regulatory Costs in the Step-Demand Framework
With Extensive Substitution
S'
Qr
Q
-------
Appendix A Using Derived Step-Demand Functions
If demand is not perfectly inelastic, there would be reduced
consumption of substitutes, and reduced costs. If necessary, the
methodology could be adapted to an alternative elasticity
assumption. All RIB analyses performed to date using this
methodology, however, have assumed that demand is perfectly
inelastic.
2. Implementation of the Step-Demand Function Methodology
The steps in the step-demand function are usually defined
using data developed in a Use and Substitutes (U/S) analysis.
The U/S analysis identifies substitutes for a product of concern,
estimates the unit cost of using each substitute in place of
Product X ("cost of substitution")—accounting for all relevant
factors such as equipment changes, reformulation costs, energy
costs, performance changes, etc., to the extent possible—and
projects how the substitutes would split up the market
(substitute market shares) in the event that Product X were
banned. U/S data therefore determines:
1. How many steps will be in the demand curve (i.e. number
of viable substitutes);
2. The height of each step (i.e. incremental cost of
substitution for each substitute ) ; and
3. The width of each step (i.e. market share for each
substitute).
Not all U/S reports fully address each of these data needs
for demand modeling. If an Economic Analysis is to make use of
this methodology, one of the first and most important tasks in
the Planning Stage is to examine the U/S report to see if all of
these points are addressed—and if they are not, to complete the
development of that data so that the step-demand curve can be
estimated. See the U/S Guidance document for more information
on the development of use and substitutes data.
A
It is not necessary to actually know F0 in this analysis. What is
necessary is to know the incremental costs of using the substitute--i.e. (Px -
P0). In many cases this can greatly simplify the data gathering process: it
is not necessary to know all the costs of current practices if the changes in
practices and their costs can be directly estimated.
5RIB How-To Guide: Use and Substitutes Reports. August 1991.
69
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Appendix A
Using Derived Step-Demand Functions
The following steps identify the tasks and data needed to
implement the step-demand methodology. Note that these steps,
and the above discussion, assume that the long-run supply curve
is horizontal and that there are no significant short-run
transition costs. These assumptions simplify the presentation of
the methodology, however, the methodology can be adapted to
alternate assumptions when necessary.
Steps in calculating costs using step-demand functions:
1. Identify distinct uses (or products) to be modeled.
2. Estimate the quantity of Product X which would be
consumed annually in the absence of regulation (Q0) in
each use.
3. Identify substitutes for Product X.
4. Estimate the incremental cost of using each substitute
in place of Product X (i.e. P, - P0) .
5. Estimate the replacement market share expected for each
substitute were Product X removed from the market.
Calculate the maximum increased quantity demanded of
the substitute as (replacement market share x Q0) .
6. Calculate the cost of ban options. Estimate costs by
calculating the area between the supply curve and the
demand curve (lost consumer surplus).
7. Calculate the cost of other options. Estimate the
shift in the supply curve by calculating the
incremental unit cost of controls. Calculate the
reduction in consumer surplus (the area left of the
demand curve and between 8 and 8'—i.e. the shaded
areas in Exhibits A-4, A-5 and A-6).
ICF Incorporated has prepared a generalized computer model
for RIB known as the VLAD which is designed to calculate the
costs of regulatory options using step-demand methodology. The
VLAD (also known as the Generalized Regulatory Cost Model) is
very flexible and is applicable to numerous situations, and a
manual on its use is available from ICF. For any analysis making
use of this methodology, the RIB analyst should evaluate the VLAD
before expending resources on developing any new computer program
or spreadsheet for calculating costs.
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Appendix A Using Derived Step-Demand Functions
3. Previous RIB analyses using the step-demand framework
The following RIB analyses each make use of the analytical
framework described in this appendix and can be consulted for
examples of how this approach was put into practice. In each of
these analyses, several step-demand functions were developed,
each representing different products or different uses of a
substance being analyzed.
Regulatory Impact Analysis of Control Options for Urea-
Formaldehyde Pressed Wood. Prepared by Abt Associates. April
23, 1992. (Ban options and performance standards for
particleboard, hardwood plywood and medium density fiberboard.
Separate demand modeling by product and by use. Very clear
presentation of analytical approach and data used.)
Regulatory Impact Analysis of Controls on Asbestos and Asbestos
Products. Prepared by ICF Incorporated. January 19,1989.
(Analysis of asbestos ban options, with numerous asbestos product
forms analyzed.)
Options for Regulating Methvlene Chloride and Perchloroethylene
in Aerosol Products; A Cost-Benefit Analysis. Prepared by ICF
Incorporated. April 16, 1990. (Ban options and engineering
controls analyzed for numerous aerosol consumer products
containing methylene chloride and perchloroethylene.)
Costs and Benefits of Regulating Methylene Chloride in Paint
Stripping Products. Prepared by ICF Incorporated. April 16,
1990. (Ban options and engineering controls analyzed for
industrial and consumer paint strippers containing methylene
chloride.)
Economic Analysis of a Proposed Ban on Chemical Grouts Containing
Acrylamide and N-methvlolacrylamide. Prepared by Abt Associates.
November 13, 1990. (Analysis of ban options for two products
with four different uses.)
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APPENDIX B
GENERIC METHODOLOGICAL ISSUES
There are several methodological issues which arise in any
economic analysis, in addition to those which are specific to a
particular analysis. Many of these issues are fundamental to the
development of analytical results which allow comparison of the
costs of any option with the benefits of that option, as well as
comparison of costs and benefits across options. This section
addresses several issues in study design necessary to insure
internal consistency and completeness in the analytical results,
including:
- Specification of the time period of analysis;
- Specification of a baseline for analysis;
- Definition of regulatory costs; and
Procedures for discounting costs and benefits.
1. Time Period of Analysis
For any analysis, it is necessary to specify a time period
for which the costs and benefits of the regulation will be
estimated. Costs of a regulatory option will usually be
calculated in present value or annualized terms for a specific
number of years, frequently based on the expected lifetime of
capital equipment purchased to comply with the rule requirements.
For example, cost results may be expressed as a present value of
all costs incurred over a fifteen year period, because equipment
is expected to last fifteen years. Benefits would then be
calculated for the same fifteen year period.
Some benefits, however, may be realized on a delayed basis.
Actions taken today in response to a regulation may result in an
avoided exposure or avoided effect several years into the future
(e.g., a product ban implemented today could result in the
avoidance of an exposure which would otherwise occur when the
product is disposed after several years of use). Benefits
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Appendix B Generic Methodological Issues
realized in the future should be counted in the analysis if they
can be directly related to actions taken during the period of
analysis used for estimating costs.
For example, if the cost analysis calculates costs over a
fifteen year period, the benefits analysis should include any
benefits realized during Years 1-15 and any benefits realized
after Year 15 which are attributable to actions taken to comply
with the regulation during Years 1-15 . Benefits realized in
Year 20 should be counted if they are related to compliance
actions taken in Year 15 or earlier; they should not be counted
if they are related to actions taken in Year 16 or later.
It is usually not necessary to extend the time period of
analysis beyond the length of a single cycle of capital
equipment. In most cases the estimated costs and benefits of
distant years will not be substantially different from those of
the first several years after the regulation goes into effect.
Also, it is usually difficult to predict those factors, such as
development of new technologies, changes in demand, or changes in
behavior patterns, which could result in substantial changes in
costs or benefits over time. The results found for the first
several years after the regulation goes into effect will
therefore usually be representative of what can be said in the
analysis regarding the impacts of the rule for the indefinite
future. In addition, costs and benefits realized many years in
the future will, when appropriately discounted, tend to have a
very limited impact on the overall cost-benefit results.
There is frequently no clear basis for determining a
specific time period for the analysis which is absolutely
"right." What is most important in selecting the time
period is that it allow the analysis to capture any specific
identified changes expected to occur over time, and that the
selected time period is applied consistently to the
calculation of both costs and benefits.
2. Specification of a Baseline for Analysis
The baseline for an analysis is a description of what is
expected to happen if the regulatory options under consideration
are not adopted. Specification of the baseline is a critical
step in conducting an economic analysis, because it provides a
basis of comparison for estimating the incremental costs and
benefits of a regulatory option.
Future benefits must be discounted to ensure proper comparison with
costs. See Section 4 of this Appendix for discussion of discounting.
73
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Appendix B Generic Methodological Issues
Definition of the baseline involves issues relating to both
costs and benefits, and in fact, is an important step in insuring
that cost estimates and benefits estimates are consistent with
one another and can be directly compared. The parameters
involved in defining the baseline for any particular substance
may include: consumption or production of the substance; number
of people exposed to the substance; and levels of exposure.
This section focuses on the specification of baseline
consumption because consumption creates the overall foundation
for the analysis, as the amount of the substance used is directly
related to the calculation of both costs and benefits:
baseline consumption enters into the cost analysis by
defining the quantity of the substance to be regulated,
whichj when multiplied by unit costs, determines total
costs
baseline consumption enters into the benefits analysis
through the relationship between the amount of
consumption and the size of the exposed population.
Assumptions made in the cost analysis and the benefits
analysis must be consistent with one another. For example, if
the cost analysis assumes that in the absence of regulation,
consumption of the regulated product would be constant over the
next fifteen years, the benefits analysis should use the same
assumption.
Three basic approaches for specifying baseline consumption
can be considered:
a. Proiect vear-by-year changes in consumption—in order to
generate the most accurate measurements of costs and
benefits, it is necessary to incorporate expected changes in
consumption during the analysis period into the baseline
estimate. It may be possible to obtain or develop very
specific estimates of the changes in consumption over time;
or it may be possible to apply constant change rates to
current consumption estimates (e.g. current consumption is 1
million units; consumption is expected to grow at 3 percent
annually). The drawback of this approach is that it could
2
Production, rather than consumption, may define the number of units
considered in the analysis, depending on the design of the regulatory option
and the difference between production and consumption of the regulated
substance. To simplify the presentation, this discussion assumes that
consumption is the basis for all calculations.
74
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Appendix B Generic Methodological Issues
greatly increase the number of calculations involved in
estimating costs and benefits without adding a great deal of
information.
b. Estimate current consumption and hold constant—in many
cases, consumption of the product is difficult to project,
is not likely to change much in the future, or does not have
much impact on the policy conclusions of the analysis. For
example, if both costs and benefits for all options are
directly proportional to consumption, the amount of
consumption will determine the magnitude of the cost and
benefit estimates, but will have no impact on the ranking of
options or on the determination of whether or not they offer
positive net benefits. In such cases, it may not be
necessary to project changes in consumption, and not
incorporating such projections could save a great deal of
effort.
c. Estimate "representative-year" consumption and hold
constant. If consumption is expected to change over time,
it may be possible to develop a consumption estimate for a
single year which is representative of consumption over the
entire period (for example, an average of the projected
annual consumption estimates). This approach combines the
advantages of the first two approaches: it accounts for
change in consumption over time, and therefore will
approximate the correct magnitude of costs and benefits,
without the need for separate year-by-year calculations.
3. Definition of Regulatory Costa
There are several issues related to the definition of social
costs which need to be recognized when preparing the cost
analysis. These include:
a. Incremental costs; the analysis should capture only those
costs that result from the implementation of a regulation,
and should not include any costs that would have been
incurred in the absence of regulation. In order to comply
with a regulation, for example, firms may have to purchase
new equipment. Because all equipment has a limited
lifetime, some firms may have had to purchase new equipment
at the time the regulation goes into effect, independent of
the regulation. In this circumstance, some or all of the
costs of the new equipment would have been incurred by the
firm in the absence of regulation, and should therefore not
be considered a cost of the regulation. Similarly, only
changes in labor, energy, raw materials and other costs
75
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Appendix B Generic Methodological Issues
attributable to regulation should be accounted for in the
cost analysis.
b. Costs vs. benefits; In an economic analysis, any positive
cost of a regulatory action can also be described as a
negative benefit, while any positive benefit of a regulatory
action can also be described as a negative cost. In
economic analysis of OPPT regulations, benefits are usually
defined as the reductions in risk to human health and the
environment . All other resource impacts, including the
consequences of all actions taken by firms and individuals
are usually counted on the cost side. For example, a
regulatory option could result in an increase in one-time
capital costs to an industry and a decrease in materials
costs. In the cost-benefit analysis, the change in
materials costs is counted as a negative cost—not as a
positive benefit.
c. costs vs. transfers; In economics, the standard definition
of a cost is the consumption of a resource. Cost estimates
should capture, to the extent possible, the opportunity cost
of the resources consumed in response to a regulation. Many
regulatory options can, however, result in transfer payments
from one party to another. For example, if a user fee is
assessed on firms, the firms must pay a certain amount to
the government. While the fee is a cost to the firm (and/or
its customers), no resources are consumed, so the fee is not
a cost to society . Cost estimates should account for all
resources consumed, but should not include transfers among
firms, consumers and government. Transfer payments should
be estimated, but should be presented separately from costs.
d. categories of costs; In addition to the direct costs
incurred as a result of a regulation, such as replacement of
a regulated substance with a more costly substitute or the
installation of exposure control equipment, the cost
analysis should include administrative costs to industry of
recordkeeping and reporting requirements, as well as costs
This definition of benefits should not be confused with the benefits of
using the regulated substance--a concept which translates into the costs of
regulation.
AIf the fee causes adjustments in the market such as substitution of
alternative chemicals or processes, the incremental costs of substitution are
a real resource cost for that portion of the market which substitutes. For
the portions of the market which do not substitute but instead pay the fee and
make no changes in operations, however, there are no real resource costs--only
a transfer payment in the form of the fee paid.
76
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Appendix B Generic Methodological Issues
to EPA for rule implementation and compliance monitoring.
In some cases, however, it may not be necessary to include a
detailed evaluation of government costs and recordkeeping
and reporting costs in the Economic Analysis (see Chapter
IV, Footnote 4 above for more discussion).
e. Short-run vs. long-run costs; Estimation of the costs of
regulations is usually based primarily on long-run costs.
Long-run cost estimates are estimates of the incremental
costs after allowing for capital investment in new
substitutes plant capacity, modifications to existing
plants, adjustments to new technology, and equilibration of
markets . Costs are calculated by comparing consumer and
producer surplus of a post-regulation long-run equilibrium
with the surpluses in the pre-regulation equilibrium. In
most cases, an analysis based on long-run costs should
capture all of the significant cost elements.
In some cases, however, substantial short-run costs could be
incurred in the transition to a new long-run equilibrium.
For example, if insufficient capacity for production of a
desirable substitute will be available at the time the
regulation is to go into effect, a shortage will result.
The many possible consequences of the shortage include:
the price of that substitute will probably rise;
some firms wishing to use that substitute may have to
use other substitutes which cost more and/or have less-
desirable properties;
some firms may have to reduce their output because they
are able to obtain only limited quantities of the
substitute; and
other firms which used the substitute in other
applications prior to the implementation of the new
regulation may find their supplies displaced by new
sources of demand which are more able to pay the short-
term price premium.
Under these circumstances, the costs of the regulation could
This conception of "long nan" allows for construction of new plant
capacity to meet increased demand, but is distinct from what may be conceived
of as a "very-long run" in which all currently existing plants have been
retired and replaced by new plants designed after the regulation was issued.
77
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Appendix B Generic Methodological Issues
be much greater in the short-run than in the long-run ,
when new substitutes production capacity is in place and the
shortage has been eliminated.
If it appears that substantial costs could be incurred in
the transition to the new long-run equilibrium, an analysis
of these short-run costs should be included in the cost
analysis. This analysis could be conducted in two stages.
In the first stage, the potential for substantial transition
costs would be evaluated qualitatively . Then, if it does
appear that the transition costs would be substantial, a
second stage of analysis could be conducted in which these
costs would be Quantified for inclusion in the overall cost-
benefit results .
4. Discounting Procedures
One of the goals in preparing an Economic Analysis is to be
able to compare the costs of a regulatory action with its
benefits. The benefits of the action, however, will often be
realized at a different time than when the costs are incurred.
For example, costs that are incurred today may be associated with
benefits that are not realized until some future point in time.
This complicates the comparison of benefits and costs because a
dollar spent today does not have the same value as a dollar
earned as a benefit tomorrow, as the dollar spent today could be
invested in some alternate activity that could earn a positive
rate of return.
In addition, the same problem of comparison arises when two
Substantial transfers from consumers to producers would also be likely
in a situation of shortage, as the price of the product is increased in the
short run. Increased costs would be borne by those who would have to use
alternatives to the product for which the shortage exists.
See the Draft Final Regulatory Impact Analysis of Control Options for
Urea-Formaldehyde Pressed Wood, pages 2-15 to 2-18, for an example of a
screening-level assessment of short-run costs.
An additional response to a situation in which substantial short-run
transition costs are expected would be to consider options with different
effective dates. For example, if it is projected that insufficient
substitutes capacity would be available for two years after a rule is
finalized, resulting in substantially increased costs for those two years, the
analysis should include an option in which the same regulatory requirement
would go into effect two years after the rule is finalized, rather than
immediately after.
78
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Appendix B Generic Methodological Issues
different regulatory options incur costs at different times.
Option A may involve a large amount of capital costs immediately
when it goes into effect and no additional costs, while Option B
incurs low capital costs but also has additional costs which are
incurred annually. Without compensating for the time
differential, it will be difficult to determine whether the
reduction in capital costs for Option B are large enough to
justify the subsequent annual costs.
This section discusses the discounting procedures and rates
to be used in RIB analyses. Discounting is the procedure by
which costs and/or benefits realized at different times are
converted into "present values" which can be directly compared
with one another. This section does not explain the theoretical
basis for discounting, but is instead focused on the steps to
take in discounting and/or annualizing cost and benefit results
in RIB RIAs. Much of the material presented in this section is
drawn from Supplemental Guidelines on Discounting in the
Preparation of Regulatory Impact Analyses, prepared by Joel D.
Scheraga, EPA/OPPE, March 1989T.
a. The Two-Stage Discounting Procedure
EPA Guidelines on discounting have established a two-stage
discounting procedure which makes use of two different discount
rates. The steps involved are:
Step 1: Annualize capital costs over the expected lifetime of
the capital equipment using the marginal rate of return
on capital, or private discount rate. In RIB,, 7
percent is used as the private discount rate . Add
annual (non-capital) costs to the annualized capital
costs to yield total annualized costs.
Step 2: Discount the stream of annualized costs at the social
In October 1992, OMB issued a revised version of its Circular A-94,
which contains guidance on discounting in regulatory analyses. This guidance
appears to take a different approach than does EPA's discounting guidance.
Changes in EPA's discounting guidance may therefore be forthcoming. Analysts
should consult the RIB Branch Chief to identify any changes in discounting
procedures.
This is a default value, based on the long-term real cost of capital to
the chemical industry, derived in An Estimate of the Cost of Capital to the
Chemical Industry, by Robert C. Dresser, IGF Incorporated, September 30, 1986.
Alternate values may be used on a case-by-case basis when there are specific
reasons for doing so.
79
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Appendix B Generic Methodological Issues
rate of time preference, or social discount rate. In
RIB analyses, 3 percent is used as the social discount
rate. The stream of benefits is also discounted using
the social discount rate.
These procedures result in the calculation of present value cost
estimates and present value benefit estimates which can be
directly compared with one another.
b. Examples of the Two-Stage Procedure
To illustrate how the two-stage discounting procedure works,
consider the following example. A regulatory option would
imposes $20 million in capital costs during the first year, for
equipment that is expected to last 15 years. In addition, there
would be $5 million in annual costs beginning in the first year.
Benefits of $8 million would be realized each year. We would
like to know whether or not this option would have positive net
benefits.
To estimate the present value of the costs of the regulation
over the fifteen year period which the capital equipment is
expected to last, it is first necessary to annualize the capital
costs, using the private discount rate. Annualization is the
calculation of the value that, if paid out in an equal amount
annually over a specified period and discounted, would be equal
to the present value . Annualization is the calculation of the
value x in the following equation:
PV = x + + + ... +
(1 + i) (1 + i)2 (1 + i)"'1
where
PV = the present value being annualized
x = the annualized value
i = the discount rate
n = the number of years over which the value is annualized
In the example, we are solving for x where PV = $20 million,
11This is identical to the types of calculations made to determine
mortgage payments or car payments.
80
-------
Appendix B Generic Methodological Issues
i = .07, and n = 15. Annualized values can be calculated easily
using a spreadsheet or a financial calculator. The annualized
cost of $20 million over 15 years at 7 percent is approximately
$2.2 million.
For purposes of calculating the costs of the regulation, the
annualized capital cost of $2.2 million is added to the $5
million in costs incurred each year for an annualized total cost
of $7.2 million.
The second stage of the discounting procedure is to convert
the annualized value into a present value, using the social
discount rate. This calculation makes use of the same equation
shown above, with different values: x is now $7.2 million (the
annualized total cost); i is .03 (since we are now using the
social discount rate instead of the private rate); n is still
fifteen years; and we are solving for PV. Again, this is a
simple spreadsheet or financial calculator operation. The
present value of an annual cost of $7.2 million over 15 years at
a 3 percent discount rate is $86 million. This is the present
value cost of the regulation over 15 years, when capital costs
are $20 million and annual costs are $5 million and when using
the two-stage discounting procedure.
To calculate the present value of benefits, the same
procedures described above for the second stage of the cost
calculation are used. In this example, the annual benefits are
$8 million per year. The present value of a 15 year annual
stream of benefits, using a 3 percent discount rate, is $96
million. This regulatory option would therefore have present
value positive net benefits of $10 million ($96 million benefits
minus $86 million costs) over the 15 year analysis period.
Note that in this example, the actual calculation of present
value costs and benefits was not absolutely necessary. Once we
had annualized costs, we had enough information to determine the
annualized net benefits of the regulation by subtracting
annualized costs from annual benefits:
$8 million benefits per year - $7.2 million costs per year
= $0.8 million annualized net benefits
In cases like this, where benefits are expressed in annual
terms which correspond to the years in which the costs are
incurred, the calculation of present value costs, benefits and
net benefits is optional. We can instead simply compare
annualized costs with annual benefits. However, if benefits vary
across years, or are expressed in future year values (for
81
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Appendix B Generic Methodological Issues
example, if annualized costs are for years 1-15 while annual
benefits are for years 5-20), further calculations will be
required: either the calculation of both costs and benefits in
present value terms; or the calculation of the present value of
benefits, then the annualization of this present value for direct
comparison of annualized costs and benefits.
Whether you choose to express costs on an annualized basis
or a present value basis, it is critical that: first, the
calculation make proper use of discounting procedures and rates
to arrive at the correct annualized value or present value; and
second, that when comparing costs with benefits, the same
procedures be used for calculation of both the costs and the
benefits. If costs are to be expressed in annualized terms,
benefits should be expressed on the same basis using the same
procedures and rates.
Additional discounting examples are shown in Exhibits B-l
through B-3.
82
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Appendix B Generic Methodological Issues
Exhibit B-l
Spreadsheet for Calculating
Present Value of Constant Annual Costs
With Increased Year 1 Costs
Year 1 cost:
Year 2-10 Annual Cost:
Social Discount Rate:
Nominal
Year Cost
1 $5,000,000
2 $1.000,000
3 $1,000,000
4 $1,000,000
5 $1.000,000
6 $1.000,000
7 $1.000,000
8 $1,000,000
9 $1,000,000
10 $1.000,000
10-Year Present Value
Annual 1 zed Cost:
$5,000,000
$1,000,000
3%
Present Value
Cost
$4,854,369
$942.596
$915,142
$888,487
$862,609
$837,484
$813,092
$789,409
$766,417
$744,094
$12,413,698
$1,455,264
83
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Appendix B Generic Methodological Issues
Exhibit B-2
Spreadsheet for Calculating
Annualized and Present Value Costs for
A Rule With Capital Costs
Capital Cost: $20,000,000
Annual O&M Cost: $1.000,000
Life of Equipment (yrs): 15
Private Discount Rate: 7%
Social Discount Rate: 3%
Step 1: Annualize Capital costs, using private discount rate.
Step 2: Add annual 1 zed capital cost to annual O&M costs.
Step 3: Calculate Present Value, using social discount rate.
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Annualized
Capital
$2,195,892
$2.195.892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2,195,892
$2.195,892
$2,195,892
$2,195,892
$2.195,892
Annual
O&M Cost
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1.000,000
$1,000,000
$1,000,000
$1.000,000
$1,000,000
Total
Annual Cost
$3,195,892
$3,195,892
$3,195.892
$3.195,892
$3.195.892
$3.195,892
$3,195,892
$3,195,892
$3,195,892
$3.195,892
$3.195,892
$3,195,892
$3,195,892
$3.195,892
$3,195,892
Fifteen- Year Present Value Cost:
Annualized Cost:
Present Value
Cost
$3,102,808
$3,012,435
$2,924.694
$2.839,509
$2,756,805
$2.676,510
$2,598,553
$2,522,867
$2,449,385
$2,378,044
$2.308,781
$2,241,535
$2,176,247
$2,112,861
$2,051,322
$38,152,357
$3,195,892
84
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Appendix B
Generic Methodological Issues
Exhibit B-3
Spreadsheet for Calculating
Net Benefits of a Two-Phase
Chemical Control Rule
Year 6 Capital Cost:
O&M cost
O&H cost
Benefits
Benefits
Step 1
Step 2
Step 3
Step 4
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Yrs. 1-5
Yrs. 6-
yrs 1-5
yrs 6-
: Annual Ize Year
: Add annual 1 zed
$30,000
$1,000
$2,000
$2,000
$6,500
6 Capital
,000
,000
,000
,000
,000
costs,
capital cost to
Life of Equipment (yrs)
: 15
Private Discount Rate:
Social Discount Rate:
using private discount
7%
3%
rate
annual O&H costs
: Calculate Present Value Costs and Benefits,
: Calculate Annual 1 zed costs and
Annual 1 zed
Capital
$0
$0
$0
$0
$0
$3.293.839
$3.293,839
$3.293.839
$3.293,839
$3.293.839
$3.293.839
$3.293,839
$3,293.839
$3,293,839
$3,293.839
$3,293.839
$3.293.839
$3.293.839
$3.293.839
$3,293.839
20-Year Present
Annual
O&M Cost
$1,000
$1,000
$1,000
$1,000
$1,000
$2,000
$2,000
$2.000
$2.000
$2.000
$2.000
$2,000
$2.000
$2.000
$2,000
$2,000
$2,000
$2.000
$2.000
$2.000
Value:
,000
,000
,000
,000
,000
,000
,000
,000
,000
,000
,000
,000
,000
.000
,000
,000
,000
,000
.000
.000
benefits for
Total
Annual Cost
$1.000.000
$1.000,000
$1,000,000
$1,000,000
$1,000,000
$5.293.839
$5.293.839
$5.293.839
$5.293.839
$5.293,839
$5,293.839
$5,293,839
$5,293.839
$5,293.839
$5.293.839
$5.293.839
$5.293.839
$5,293.839
$5.293.839
$5.293,839
20-year Annual) zed:
using social discount
rate.
20-year period.
Present Value
Cost
$970,
$942.
$915.
$888.
$862,
$4.433.
$4.304,
$4.179,
$4.057.
$3.939.
$3.824.
$3.712.
$3,604,
$3.499.
$3.397.
$3,298,
$3.202.
$3.109.
$3,019.
$2.931.
$59,094,
$3.972,
Annual
Benefits
874
596
142
487
609
507
375
005
287
113
382
992
847
851
914
945
859
572
002
070
429
074
PV Net Benefits
Annual 1 zed Net Benefits •
$2,
$2.
$2,
$2.
$2.
$6.
$6.
$6,
$6.
$6.
$6,
$6,
$6,
$6,
$6,
$6.
$6.
$6,
$6,
$6,
$17.
$1.
000,
000,
000,
000,
000,
500,
500,
500,
500.
500.
500,
500,
500,
500.
500,
500,
500,
500,
500,
500,
000,
142,
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
000
476
699
Present Value
Benefits
$1
$1
$1
$1
$1
$5
$5
$5
$4
$4
$4
$4
$4
$4
$4
$4
$3
$3
$3
$3
$76
$5
.941.748
.885,192
,830,283
.776,974
,725.218
,443.648
,285,095
,131,160
,981,709
,836,610
,695.738
.558,969
,426,184
,297.266
.172.103
.050.585
.932.607
.818.065
.706.859
,598.892
,094.904
,114,773
85
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Appendix B Generic Methodological Issues
c. Discounting Benefits
It is beyond the scope of this document to review economic
theory relating to the discounting of benefits. As indicated
above, however, EPA Guidelines on discounting and RIB policy
indicate that benefits should be discounted using the social
discount rate (3 percent). Benefits are discounted both when
they are expressed in monetized (dollar-value) terms and when
expressed in non-monetized terms. Non-monetized benefits are
discounted in the exact same manner as monetized benefits.
An additional issue that arises in benefits analysis is
whether benefits should be discounted from the time of exposure
or from the time of effect. For example, exposure to a
carcinogen five years from now may result in the onset of cancer
in some individual 25 years from now. The issue that may be
raised is whether to discount the case to present value from Year
5 or from Year 25.
There is no clearly established policy on this matter. If
the benefits are monetized, the methodology by which the unit
dollar-value (dollars per case avoided) is derived may dictate
the best approach. Dollar values used in RIB benefits analyses
are usually drawn from studies addressing risk scenarios
different from those being considered in the benefits analyses.
Therefore, it is necessary to consider how to apply the dollar
estimate created for a different scenario to a new scenario.
For example, if a dollar-value estimate to be used in a RIB
benefits analysis already accounts for a delay in the time
between exposure and effect, it may be redundant to then discount
benefits from the time of effect—the analysis would effectively
be discounting benefits twice. If, however, the dollar-value is
drawn from a scenario in which the effect is realized immediately
at the time of exposure, while the effect considered in the
benefits analysis occurs only after some delay, it may be
appropriate to account for that delay by discounting. This is an
issue which the analyst should evaluate on a project-by-project,
effect-by-effect basis.
86
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APPENDIX C
FRAMEWORK FOR QUANTITATIVE BENEFITS ANALYSIS
In the preparation of RIAs for substances considered for
regulation under TSCA Section 6, the availability of the data
needed for benefits analysis tends to vary considerably. Some
substances and some effects have been studied extensively, and
the depth and breadth of data available makes it relatively easy
to quantify and monetize benefits . Quantification and
monetization of the benefits of regulating other substances,
however, may be accomplished only with substantial original
research.
This appendix discusses different approaches to benefits
analysis appropriate for varying levels of data availability. It
first describes the steps taken in a benefits analysis when
effects can be quantified and monetized, then discusses
alternative approaches that can be used when benefits can not be
readily monetized or quantified. While this appendix focuses on
the quantification of benefits, it is important that any cost-
benefit analysis discuss in detail the nature of any benefits
which can not be quantified.
A Risk Assessment is usually the point of departure for a
benefits analysis. The Risk Assessment summarizes and integrates
all information on hazard and exposure, presents estimates of
baseline risk, and characterizes the strength of the risk
estimates and any associated uncertainties.
In a Risk Assessment, risks may be described in terms of
either population risk or individual risk. Population risk is an
aggregate measure of the projected frequency of effects among all
exposed people, such as "4 cancer cases per year." Individual
Vhen the two terms are used together, "quantification" of benefits
usually refers to the calculation of a number of cases of an effect or some
other physical measure of health or environmental effects, while
"monetization" refers to the valuation of benefits in dollar terms.
Frequently, however, the term "quantification" is used to refer to both of
these steps in benefits analysis.
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Appendix C Framework for Quantitative Benefits Analysis
risk is an estimate of the probability of an exposed individual
experiencing the adverse effect, such as "1 in 1000" (or "10" ")
risk of cancer .
For cost-benefit analysis, population risk estimates are
preferable to individual risk estimates, because they enable
estimation of total benefits which can be directly compared to
total costs. If the Risk Assessment does not present population
risks, the RIB analyst should work with the workgroup members
responsible for risk assessment to develop population risk
estimates.
1. Steps to Follow When Benefits can Be Quantified and
Monetized
a. Determine baseline exposure
Exposure estimates are usually developed by the Chemical
Engineering Branch (occupational exposure) and the Exposure
Assessment Branch (all other exposures). The primary outputs of
an exposure analysis are:
Identification of exposed populations (e.g.
occupational groups, consumers of particular products,
general population living in particular areas) and the
number of exposed individuals in each group.
- Level, duration and frequency of exposure (e.g. 100 ppm
time-weighted average exposure for an eight-hour day,
50 days per year).
b. Translate baseline exposure into baseline number of cases
for each quantifiable effect
This step involves combining dose-response estimates (i.e.
risk per unit of exposure) with the exposure assessment. For
cancer assessments, dose-response is usually modelled as a linear
no-threshold relationship—that is, every unit of exposure
contributes equally to aggregate risk. For example, 100 units of
human exposure results in a given amount of risk, regardless of
whether there is a one-time exposure of 100 units to one person,
10 exposures of one unit each to 10 different people, or one time
Individual risk calculations are frequently based on a hypothetical
"most exposed individual." The result is referred to as an "MEI risk."
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Appendix C Framework for Quantitative Benefits Analysis
exposures of one unit each to 100 different people. The estimate
of the dose-response relationship for a carcinogen is known as a
"slope factor" or as a "Q-l star" (q^) . For other effects, dose
response relationships may include a threshold, and/or may be
non-linear with respect to the level of exposure.
Calculation of the baseline number of cases for each exposed
population involves the multiplication of the baseline number of
people exposed times the amount (level, duration and frequency)
of baseline exposure times the slope factor. In some projects,
this calculation will be performed by the exposure assessors,
while in other projects RIB will have to make this calculation.
c. Determine the post-regulatory exposure level and exposed
population
To determine the number of cases after regulation, it is
first necessary to know the impact of the regulatory option on
exposure levels and on the number of people exposed. The impact
of the regulation on exposure depends on the type of option and
the expected market response to the option.
For a ban option, all exposure associated with the source
being controlled and post-regulatory exposure is zero, unless
there are "background" exposures to the toxic substance from
other sources which have been included in the baseline exposure
estimate. In these cases, post-regulatory exposure under a ban
option is equal to background exposure.
For options other than bans, however, this assessment is
more complicated. There are two dimensions to characterizing
post-regulatory exposure. First, it is necessary to estimate the
impact of the option on exposure levels. For example, a
regulatory option may reduce (but not eliminate) the exposure to
the toxic substance in a particular use. It is then necessary to
estimate the expected post-regulatory level of exposure for that
use.
Second, the market impact of the regulatory control needs to
be evaluated. If the regulatory option increases the costs of
producing or using a substance, the use of the substance may
decline , resulting in reduced events of exposure. This portion
of the benefits assessment draws directly from the results of the
cost assessment: if the cost analysis finds that the substance
2
See Appendix A for a discussion of a typical approach to modeling market
impacts.
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Appendix C Framework for Quantitative Benefits Analysis
retains 75 percent of its market and is replaced by substitutes
in the other 25 percent of the market, then it is reasonable to
assume that baseline exposure is reduced by 25 percent. In most
cases, this would imply a 25 percent reduction in the number of
people exposed—although it could instead reduce the frequency,
duration or intensity of exposure, depending on the particular
situation.
Two separate effects are therefore involved in
characterizing post-regulatory exposure for non-ban options. The
first effect—the direct effect of controls—tends to reduce the
amount of exposure for those people who are exposed. The second
effect of the controls is to reduce the usage of the targeted
substance, and therefore to indirectly reduce the size of the
exposed population.
d. Translate post-recrulatory exposure into post-requlatorv
number of cases for each quantifiable effect
In this step, Step b is repeated, using the post-regulatory
estimates of exposure (number of people exposed, frequency,
duration and level of exposure) derived in Step c. Multiplying
the new exposure estimates by the dose-response estimate yields
an estimate of the post-regulatory number of cases.
e. Subtract post-regulatory cases from baseline cases to
determine cases avoided
To determine the number of statistical cases avoided as a
result of a regulatory option, the post-regulatory number of
cases (from Step d) are subtracted from the pre-regulatory number
of cases (from Step b). These are the quantified benefits of the
regulation, unless there are new risks associated with increased
exposure to substitutes which can be quantified. Any risks of
substitutes should be quantified using the same procedures
identified in Steps a and b above, and used in the calculation of
benefits as follows:
Baseline Post-Regulatory Post-Regulatory
Benefits = Risk of Target - Risk of Target - Risks of New
Substance Substance Exposures to
Substitutes
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Appendix C Framework for Quantitative Benefits Analysis
f. Multiply n"ifffcer of cases avoided bv value per case avoided
to determine dollar-value benefits
When possible, it is desirable to express benefits in dollar
terms, so that they can be directly compared with costs.
Benefits values are usually expressed on a cases-avoided basis,
that is, $X per case of effect Y avoided. The best estimate of
the value of a case avoided is a willingness-to-pay estimate.
Benefits values based on a willingness-to-pay estimate will be
the most comprehensive, taking into account direct medical costs
as well as pain, suffering, foregone income, decreases in the
quality of life, etc.
If an estimate based on willingness-to-pay methodology is
not available, it may be desirable to use an estimate based on a
direct-valuation methodology as a lower bound value. Direct
valuation methodologies can take into account some components of
a willingness-to-pay estimate, such as lost income and costs of
medical treatment, but cannot account for other aspects such as
pain, suffering, and losses in the quality of life. The
presentation of a benefits analysis should always make clear what
type of methodology—e.g. willingness-to-pay, or some other,
partial-valuation approach—has been used to develop the value
per case avoided for each effect.
To determine total monetizable benefits, multiply the number
of cases of each effect avoided by the value per case avoided,
and sum up the total for all effects valued. If there are risks
of substitutes which can be quantified and monetized, these
should be subtracted from the benefits of reducing exposure to
the targeted substance.
2. Steps to Follow When Benefits Can Be Quantified But Not
Monetized
For some substances and effects, the scientific research is
sufficient to support a calculation of the number of effects
avoided by regulation, but there is insufficient economic
research to support a valuation of the avoided effects. In these
analyses, the first five steps of the benefits analysis are the
same as above to determine the number of effects avoided. Non-
monetized benefits are then compared with costs in a cost-
effectiveness analysis. Cost-effectiveness analysis involves the
division of costs by the number of cases avoided to estimate the
cost per case avoided. This yields a break-even value; when the
value of avoiding the effect is greater than the cost-
effectiveness estimate, the option will have positive net
benefits; when the value of avoiding the effect is less than the
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Appendix C Framework for Quantitative Benefits Analysis
cost-effectiveness value, the option will have negative net
benefits. See Appendix E for a more detailed discussion of cost-
effectiveness analysis.
3. Benefits Analysis When Cases Avoided Can Not Be Quantified
In some analyses, it is not possible to quantify the
expected number of cases because there are insufficient data
available to support the estimation of a dose-response
relationship. In these instances, the risk concern for the
chemical is frequently expressed by the estimation of an effects
threshold, and a comparison of estimated exposures to this
threshold. Thresholds are usually described as being a NOAEL
("no observed adverse effect level") or a LOAEL ("lowest observed
adverse effect level"), and are determined by observation of the
effects in animal studies, or when possible, human
epidemiological studies.
Even when exposures are estimated to be below the threshold,
there is often a high degree of regulatory concern. When the
margin of exposure (MOE—determined by dividing the NOAEL or
LOAEL by the exposure level) for a serious effect is less than
100, EPA decisionmakers often feel that the margin of safety for
exposed people is inadequate and may justify regulatory
attention. In such a case, developing any benefits analysis may
be especially difficult, as there is no estimate of a number of
cases of the effect, and there are no estimated exposures above
the threshold. In these instances, more novel approaches and
original research on the willingness-to-pay to avoid such
exposures may be necessary to develop benefits estimates.
When exposures are above the threshold, it may be possible
to develop a benefits measure by calculating the aggregate amount
of exposure above the threshold—for example, benefits could be
expressed in terms of "avoided person-years of exposure above the
threshold." This value can then be used in a cost-effectiveness
analysis. See Regulatory Impact Analysis of Control Options for
Urea-Formaldehyde Pressed Wood. Draft Final Report, Abt
Associates, April 23, 1992, for an example of this type of
analysis.
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Appendix C Framework for Quantitative Benefits Analysis
4. Non-Cancer Benefits Model
RIB has developed an interactive computer model to
facilitate the quantification of changes in incidence of human
health effects, other than cancer, expected as a result of
changes in exposure to toxic substances. Depending on data
availability, the model will estimate health benefits as
decreases in risks of specific harmful effects, or as decreases
in degrees of exposure above threshold exposure levels.
The model provides RIB with in-house health benefits
estimation capabilities. In addition to providing a consistent
and efficient approach to benefits estimation, the model allows
RIB analysts to perform sensitivity analyses by changing
parameter values. The model can be run on any IBM compatible
computer with a 286 level processor or better. Three documents
prepared by RIB's contractor, Research Triangle Institute, are
available to guide the analyst in the use of the model:
A Computer Model for the Estimation of Noncancer Health
Benefits of Regulations. Draft, December 1990
A Computer Model for the Estimation of Noncancer Health
Benefits of Regulations—Volume 1; User Manual. August 1992
A Computer Model for the Estimation of Noncancer Health
Benefits of Regulations—Volume 2; Computer Programs.
August 1992.
5. Direct Cost of Illness Estimates
Direct costs of illness include expenses such as the cost of
medical care and time away from work. In the absence of
estimates of the complete willingness-to-pay, cost of illness
estimates provide a partial estimate of the willingness-to-pay.
RIB has developed cost of illness estimates for five health
effects which have figured prominently in past EPA regulations:
asthma; chronic obstructive pulmonary disease; lung cancer;
coronary artery disease; and asymptomatic high blood lead levels
in children. A detailed description of the methodology and the
direct cost estimates are provided in Quantifying the Benefits of
Reduced Morbidity and Mortality. Abt Associates, September 1991.
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APPENDIX D
VALUATION OF DEATHS AVOIDED IN BENEFITS ANALYSIS
In many RIB RIAs, the primary benefit is reduction in the
risks of death. These benefits are frequently calculated and
expressed as "statistical deaths avoided" by combining exposure
data with dose-response estimates. The economics literature on
the value of deaths avoided is rather extensive, and provides a
relatively strong basis for monetizing benefits when deaths
avoided can be calculated.
When monetizing benefits for deaths avoided, it is RIB
policy is to use $11 million per statistical death avoided as a
leading estimate, while using $2.5 million as a sensitivity
analysis value. These estimates are in 1990 dollars, and should
be updated using growth in nominal GNP. This appendix provides
further background on these values. As of this writing, it
appears that OPPE will be initiating an effort to standardize
Agency valuation procedures for statistical deaths avoided. The
guidance contained in this appendix may therefore be superseded
by Agency-wide guidance at some point in the future.
The $11 million estimate is derived from a paper by Ann
Fisher, Lauraine G. Chestnut and Daniel M. Violette entitled "The
Value of Reducing Risks of Death: A Note On New Evidence ."
This paper is the best, most comprehensive and most up-to-date
source that has addressed this issue. The paper states that "The
most defensible empirical results indicate a range for the value-
per-statistical-life estimates of $1.6 million to $8.5 million
(in 1986 dollars)."
In the course of developing the RIAs for lead solder and
lead in brass fittings, it was necessary to update the estimated
range to 1990 dollars. Two alternative methods for updating the
estimate were considered. The first method accounts for
inflation, using the gross domestic product implicit price
deflator. The deflator indicates a rise in price levels of 16.5
Journal of Policy Analysis and Management, 1989, Vol. 8, No.l, pp. 88-
100.
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Appendix D Valuation of Deaths Avoided in Benefits Analysis
percent from 1986 to 1990 . Inflating the Fisher estimate by
this amount results in a new range of $1.9 million to $9.9
million per statistical life.
The second method accounts for inflation and increases in
real national income, assuming that the value of avoiding death
increases as real incomes increase. Under this method, the
estimate is updated in proportion to increases in nominal GNP.
Nominal GNP grew by 29 percent from 1986 to 1990 . Inflating
the Fisher estimate using nominal GNP results in a new range of
$2.1 million to $11.0 million per statistical life—about ten
percent greater than the range determined using the first method.
RIB has chosen to use the second, broader approach to
inflating the value of deaths avoided, because it seems
reasonable to conclude that society would be willing to pay more
to avoid deaths as its income grows. This is an issue which may
be explored further in the development of the Agency-wide
guidance.
In addition, RIB has chosen to use the upper end of the
updated range of $2.1 million to $11 million, for two reasons.
First, using the upper end of the range has been past practice in
OPPT/OTS, based on previous informal guidance from OPPE. The
practice of using the upper end originated with informal guidance
from OPPE to OTS during 1987 in the course of the chlorinated
solvents project. In this project, RIB prepared four separate
economic analyses of regulatory options to reduce risks of cancer
from exposure to chlorinated solvents. Each of these, analyses
calculated cancer cases avoided for several regulatory options.
In the early stages of this project, it was OPPE's advice that we
use the upper end value for statistical deaths avoided, and we
have done so ever since.
Second, the Fisher paper does not suggest that greater
confidence should be placed in values toward the lower end of the
range—if anything, it places more weight on the higher values
when it states that "Available information seems to indicate that
the estimates...would be expected to understate the value per
statistical life appropriate for environmental policy
assessment.11
2Price deflator is 112.9 for 1990 and 96.9 for 1986; 112.9/96.9 - 1.165.
3Nominal GNP was $5524.5 billion in 1990 and $4277.7 billion in 1986;
5524.5/4277.7 - 1.29.
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Appendix D Valuation of Deaths Avoided in Benefits Analysis
In addition, placing greater weight on the lower end of the
range in a current rulemaking would effectively preclude OPPT
from using the higher end of the recommended range in future
rulemakings. Until an Agency-wide perspective is developed on
the value of statistical deaths avoided, RIB should not commit to
a lower value which will limit its flexibility to use the upper
portion of the range in future rulemakings.
RIB does, however, use a value toward the lower end of the
range as a sensitivity analysis in its RIAs. In the course of
rule development for lead solder and lead in brass fittings, $2.5
million was selected as a sensitivity analysis value, because
that value had been used as leading estimate by the Office of
Drinking Water in its previous RIA dealing with reduction of lead
in drinking water.
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APPENDIX E
COST-EFFECTIVENESS ANALYSIS
In many RIB analyses it is possible to quantify benefits,
but sufficient data are not available to allow monetization of
the effects. It is then not possible to derive net benefits,
because the costs are expressed in dollar terms while the
benefits are expressed in other terms such as "cases avoided" of
a particular health effect.
When benefits are quantified but not monetized, a cost-
effectiveness analysis should be performed. Cost-effectiveness
values are determined by dividing costs, expressed in dollar
terms, by benefits, expressed in units such as cases avoided. A
cost-effectiveness analysis is a tool for determining which
options are preferred given different assumptions regarding the
value of the non-monetized benefit.
1. Average and Incremental Cost-Effectiveness Calculations
To illustrate the basic concept of cost-effectiveness,
consider a regulatory option (Option A) which would cost $10
million per year and would result in ten cases avoided per year
of some adverse health effect. The average cost-effectiveness of
this option would be $1 million per case avoided. This
calculation of average cost-effectiveness yields a "break-even"
value: if the value of avoiding the health effect is more than
the break-even value of $1 million per case, the regulatory
option will have positive net benefits; if the value of avoiding
the effect is less than $1 million per case, the option will have
negative net benefits.
Cost-effectiveness analysis is also a useful tool for
helping to determine the desirability of selecting regulatory
options which provide different levels of benefits. The
calculation of incremental cost-effectiveness—the cost per case
avoided for the additional cases avoided when comparing an option
with lower benefits to one with greater benefits—provides an
index for determining whether or not the option with greater
benefits has greater net benefits.
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Appendix E Cost-Effectiveness Analysis
Consider a second regulatory option (Option B) which would
avoid 15 cases per year at a cost of $30 million. Using the same
procedures as for Option A, the average cost-effectiveness of
Option B is $2 million per case avoided. However, in order to
determine whether it is worthwhile to move from the less-costly
Option A to the more costly Option B, it is necessary to
calculate the incremental cost effectiveness.
Incremental cost-effectiveness is determined by dividing the
change in costs by the change in benefits. In this example, the
incremental costs of Option B are $20 million ($30 million - $10
million) and the incremental benefits are five cases (15 cases -
10 cases); the incremental cost-effectiveness is therefore $4
million per case. If the value per case avoided is greater than
$4 million per case, Option B will have greater net benefits than
Option A, because the increase in benefits over Option A will
exceed the increase in costs over Option A. In other words, the
incremental risk reduction will have positive net benefits, so it
will increase total net benefits.
If the value per case avoided is less than $4 million,
however, Option B will have lower net benefits than Option A,
because its increase in costs will exceed its increase in
benefits. The incremental cost-effectiveness has more meaning
than the average cost-effectiveness because it provides a
criterion for determining whether or not one option offers
greater net benefits than another.
Cost-effectiveness analysis can also be used to identify
whether any of the options analyzed can clearly be judged to be
inferior to other options on efficiency grounds. Any time that
one option offers fewer benefits than a second option and has a
greater incremental cost per case avoided, it will be an inferior
option. The second option would always be preferred, because it
offers more benefits at a lower incremental cost per case.
Consider Option C, which would avoid 12 cases per year at a
cost of $20 million. Compared with Option A, it avoids 2
additional cases per year at an incremental cost of $10 million
per year. The incremental cost-effectiveness is therefore $5
million per case. However, Option B offers greater benefits (15
cases avoided per year) than Option C at a lower incremental cost
per case ($4 million). If it is worth $5 million per case to
avoid two incremental cases with Option 3, then it would always
be worth $4 million per case to avoid five incremental cases with
Option B. Option B will always have greater net benefits than
Option C, given that Option A has positive net benefits, because
it achieves greater incremental benefits at a lower incremental
cost per unit.
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Appendix E Cost-Effectiveness Analysis
2. Steps in cost-effectiveness analysis
This section presents the steps taken in preparing a cost-
effectiveness analysis, using the hypothetical cost and benefit
estimates for a set of regulatory options shown in Exhibit E-l as
an example.
a. Compile all costs and benefits (cases avoided) in a table,
with options placed in order from lowest to greatest number
of cases avoided (see Exhibit E-l).
b. Your analysis should always include a "No Action" option,
which has no costs or benefits (Option 1 in the example).
This will always be the first efficient option. To
determine the second efficient option, divide costs by
benefits for all options to determine the incremental cost-
effectiveness for each option compared with Option 1, and
identify the option with the lowest average cost-
effectiveness ratio (when compared with the no action
option, average cost-effectiveness equals incremental cost-
effectiveness) . In the example, Option 3 is the second
efficient option (see Column 1 of worksheet shown in Exhibit
E-2) .
c. To determine the next efficient option, calculate the
incremental cost effectiveness for each option with benefits
greater than the previous efficient option (Option 3 in this
case). Incremental cost-effectiveness is calculated by
dividing incremental costs by incremental benefits:
Incremental cost-effectiveness =
C08TSB - COSTSA
BENEFITS,, - BENEFITS^
The option with the lowest incremental cost effectiveness is
the next efficient option. In the example, this is Option 7.
(see Column 2 of Exhibit E-2).
d. Repeat Step c as many times as needed, until the option
offering the greatest benefits is the only remaining option.
This option is always an efficient option, because no other
option can achieve the same level of benefits. (Remember:
efficient options do not necessarily have positive net
benefits.) By repeating Step c, Options 9 and 10 in the
example are also identified as efficient options (see
Columns 3 and 4 of Exhibit E-2).
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Appendix E Cost-Effectiveness Analysis
Exhibit E-l
Costs and Benefits of Regulatory Options
Costs Cases
Option ($MM) Avoided
1. 00
2. 20 4
3. 10 5
4. 30 8
5. 60 15
6. 120 18
7. 75 25
8. 140 30
9. 150 35
10. 270 38
100
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Appendix E Cost-Effectiveness Analysis
Exhibit E-2
Worksheet for Identifying Efficient Options
Incremental Cost-Effectiveness
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Costs
($MM)
0
20
10
30
60
120
75
140
150
270
Cases
Avoided
0
4
5
8
15
18
25
30
35
38
($MM
1
__
5
2
3.8
4
6.7
3
4.7
4.3
7.1
per case
2
6.7
5
8.5
3.3
5.2
4.7
8
avoided)
3
13
7.5
15
4
40
Note: Efficient options are identified by finding the option
with the lowest value in each of the four incremental cost-
effectiveness columns (shown in bold). Incremental cost-
effectiveness is calculated as the change in costs divided by the
change in benefits for any option, when compared with an
efficient option.
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Appendix E Cost-Effectiveness Analysis
e. Prepare a results table which shows the costs and benefits
for all options and the incremental cost-effectiveness for the
efficient options (see Exhibit E-3). You are now ready to
interpret the results of your analysis. In the example:
if the value per case avoided is less than $2 million,
Option 1 (No Action) provides the greatest net benefits (all
other options have negative net benefits);
if the value per case avoided is greater than $2 million but
less than $3.3 million, Option 3 provides the greatest net
benefits;
if the value per case avoided is greater than $3.3 million
but less than $7.5 million, Option 7 provides the greatest
net benefits;
if the value per case avoided is greater than $7.5 million
but less than $40 million, Option 9 provides the greatest
net benefits; and
if the value per case avoided is greater than $40 million,
Option 10 provides the greatest net benefits.
There is no positive value per case avoided for which Options 2,
4, 5, 6, or 8 will have the greatest net benefits.
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Appendix E Cost-Effectiveness Analysis
Exhibit E-3
Cost-Effectiveness Analysis Results
Option
1
2
3
4
5
6
7
8
9
10
Costs
($MM)
0
20
10
30
60
120
75
140
150
270
Cases
Avoided
0
4
5
8
15
18
25
30
35
38
Incremental Cost-
Effectiveness ($MM/Case)
__
2
3.3
7.5
40
Note: Incremental cost-effectiveness is calculated for efficient
options only.
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Appendix E Cost-Effectiveness Analysis
3. Graphing the Cost-effectiveness Analysis
Exhibit E-4 illustrates the cost-effectiveness analysis in
graphic form. This type of graph is useful for confirming the
calculated results of the analysis and for providing a visual
representation of the costs and benefits which allows easy
comparison of the options. The following steps are used in
preparing this kind of graph:
a. Place cost on the vertical axis and benefits on the
horizontal axis.
b. Plot a point on the graph for each option.
c. Draw a straight line from the origin to the point lying
closest to the horizontal axis.
d. Draw a straight line from that point to the point to its
right (greater benefits) which is closest to the horizontal
axis.
e. Continue drawing lines until the point representing the
greatest benefits is reached.
The connected lines are called the "efficient options
frontier," as each of the connected options is an efficient
option. The slope of each line segment is equal to the
incremental cost of moving to the next option. When drawn
correctly, the frontier will always be convex, and there will be
no points below or to the right of the frontier. If the frontier
is not convex, an option which is not efficient has been
included; if there are any points below or to the right of the
frontier, an option which is efficient has been excluded.
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Appendix E
Cost-Effectiveness Analysis
Exhibit E-4
Illustration of the Cost-Effectiveness Analysis
300
Cost
($MM) 250
10
10
35 40
Cases
Avoided
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APPENDIX F
ANALYSIS OF IMPACTS
"Impacts analysis" is a general term used to describe
various economic analyses which are supplemental to the estimates
of total costs and benefits. These analyses are usually
concerned with examination of the types of costs, the
distribution of costs and benefits, and the effects of the
regulation on macroeconomic variables. These analyses go beyond
the aggregate estimates of costs and benefits to examine various
aspects of the composition of costs and benefits. While many
types of impacts analysis can be conducted , five particular
categories of impacts analysis tend to be most important for OPPT
rules:
Impacts on small entities (under the requirements of
the Regulatory Flexibility Act);
Impacts on paperwork burdens (under the Paperwork
Reduction Act);
Trade impacts;
- Innovation impacts;
Equity effects.
In general, the goal of impact analyses is to supplement the
cost-benefit analysis and the other information available to
decisionmakers on the consequences of selecting a particular
regulatory option for proposal or promulgation . These analyses
See Appendix D of the EPA Guidelines for Performing Regulatory Impact
Analysis for discussion of several types of impacts analysis.
2The level of depth desirable in the impacts analyses at the Economic
Analysis stage may vary. In some cases, a qualitative, screening level
analysis of impacts may suffice for the Economic Analysis, particularly when
impacts are expected to be small, with more detailed analysis conducted for
the RIA after the Regulatory Decision. In other cases, more detailed and
quantitative analysis of impacts should be included in the Economic Analysis.
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Appendix F Analysis of Impacts
should not be taken on their own to indicate any particular
option as a preferred option, nor to disqualify any particular
option.
1. Regulatory Flexibility Analysis
The Regulatory Flexibility Act requires Federal regulatory
agencies to determine whether or not a proposed regulation will
have a significant impact on a substantial number of small
entities. If such an impact appears likely, the agency is
required to prepare a Regulatory Flexibility Analysis which
identifies and analyzes alternatives which would reduce the
impact on small entities.
Current Agency policy on the implementation of the
Regulatory Flexibility Act, described in EPA Guidelines for
Implementing the Regulatory Flexibility Act,, Revised April 1992,
requires that a Regulatory Flexibility Analysis be prepared for
any rule which would have any impact on small businesses.
In most cases, the best way to prepare for the requirement
to prepare a Regulatory Flexibility Analysis is to include
less burdensome regulatory options in the Economic Analysis
beginning in the Planning Stage. The analyst then does not
need to go back and create and analyze new options at the
end of the project to satisfy the Regulatory Flexibility
requirements.
In a Regulatory Flexibility Analysis, measures of the impact
of the preferred option on businesses of different sizes are
calculated, and are compared with the same calculations for
alternative regulatory approaches which would have reduced impact
on small businesses. For example, the average annual costs per
firm in a particular size class (e.g. 10 - 19 employees), divided
by the average annual sales for firms in that size class,
determines costs as a percentage of sales. This figure can be
compared across size classes and across options to characterize
the impacts on small business. An example of this type of
analysis can be found in Chapter 8 of the Draft Final Regulatory
Impact Analysis of Control Options for Urea-Formaldehyde Pressed
WoodJ.
Analysts should consult RIB management to determine the level of impacts
analysis to be included in the Economic Analysis.
Note that the Formaldehyde Regulatory Flexibility Analysis was conducted
according to a previous version of the Agency guidance. Therefore, not all of
the material in this analysis is consistent with the 1992 guidelines. The
107
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Appendix F Analysis of Impacts
2. Paperwork Reduction Act Analysis
In many rulemakings concerned with controlling the
production or use of a toxic substance, various recordkeeping,
reporting, labeling, testing and other requirements are included
to help EPA verify compliance with the rule after it has been
promulgated. In other cases, the establishment of reporting
requirements is the central purpose of the rulemaking. Under the
requirements of the Paperwork Reduction Act (PRA), the Agency is
required to estimate the "burden hours" associated with the
recordkeeping and reporting requirements, and to present these
estimates for OMB review in a standardized document known as an
Information Collection Request (ICR) .
RIB is responsible for preparing estimates of burden hours
associated with recordkeeping and reporting requirements, while
the workgroup chair for the rulemaking is responsible for
preparing the ICR itself. Burden hours should be estimated in
the course of estimating the costs of any administrative
requirements in Chapter 4 of the RIA. This section of the RIA
should summarize the burden hour estimates, so that they can be
easily incorporated into the ICR.
3. Trade Impacts Analysis
This section presents an evaluation of any expected impacts
of the regulation on the United States balance of trade. Where
possible, the trading partners of the U.S. which would be
affected by the rule should be identified, and the dollar value
of trade affected should be estimated.
4. Innovation Impacts Analysis
This section presents an evaluation of any impacts which the
regulation might have on technological innovation.
calculations contained in this analysis continue are, however, consistent with
the new guidelines and serve as a useful model.
*Under the PRA, burden hour estimates and ICRs are not required for
paperwork requirements that affect fewer than ten entities.
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Appendix F Analysis of Impacts
5. Equity Effects Analysis
Equity effects analysis is an examination of which groups in
society are expected to gain from a regulation, which groups are
expected to lose, and the magnitude of these, gains and losses.
This section should address any significant issues regarding the
distribution of gains (who realizes reduced risk; what firms,
industries or products have increased sales and/or profits) and
losses (who bears new costs, reduced sales or profits, or
increased risks) in industry and in the population at large.
Current use of the term "equity effects" in EPA most
frequently refers to a focus on the determination of whether or
not any racial minority or low-income community bears a
disproportionate risk. In the context of RIB RIAs, this probably
means considering: first, whether the baseline risk is borne
disproportionately; and second, whether any risk after regulation
(residual risk, new risk, or transfer of risk) is borne
disproportionately by such groups. While no guidelines for
equity analysis have been established, this may be a relevant
issue for some OPPT rulemakings which should be addressed in some
manner. Analysts should consult with RIB management to determine
the current guidance on conducting equity effects analysis.
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Appendix F Analysis of Impacts
APPENDIX G
TEXT OF EXECUTIVE ORDER 12291 AND
OMB'8 REGULATORY IMPACT ANALYSIS GUIDANCE
110
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APPENDIX I
Executive Order No. 12291
EXECUTIVE ORDER No. 12291 OF FEBRUARY 17, 1981
Federal Regulation
By the authority vested in me as President by the
Constitution and laws of the United States of Amer-
ica, and in order to reduce the burdens of existing
and future regulations, increase agency accountabil-
ity for regulatory actions, provide for presidential
oversight of the regulatory process, minimize dupli-
cation and conflict of regulations, and insure well-
reasoned regulations, it is hereby ordered as follows:
Section 1. Definitions. For the purposes of this Order:
(a) "Regulation" or "rule" means an agency state-
ment of general applicability and future effect de-
signed to implement, interpret, or prescribe law or
policy or describing the procedure or practice require-
ments of an agency, but does not include:
(1) Administrative actions governed by the provi-
sions of Sections 556 and 557 of Title 5 of the United
States Code;
(2) Regulations issued with respect to a military or
foreign affairs function of the United States; or
(3) Regulations related to agency organization,
management or personnel.
(b) "Major rule" means any regulation that is likely
to result in:
(1) An annual effect on the economy of $100 million
or more;
(2) A major increase in costs or prices for consum-
ers, individual industries, Federal, State, or local
government agencies, or geographic regions; or
(3) Significant adverse effects on competition, em-
ployment, investment, productivity, innovation, or on
the ability of United States-based enterprises to com-
pete with foreign-based enterprises in domestic or
export markets.
(c) "Director" means the Director of the Office of
Management and Budget.
(d) "Agency" means any authority of the United
States that is an "agency" under 44 U.S.C. 3502(1),
excluding those agencies specified in 44 U.S.C.
3502(10).
(e) Task Force" means the Presidential Task Force
on Regulatory Relief.
Sec. 2. General Requirements. In promulgating new
regulations, reviewing existing regulations, and de-
veloping legislative proposals concerning regulation,
all agencies, to the extent permitted by law, shall
adhere .to the following requirements:
(a) Administrative decisions shall be based on ade-
quate information concerning the need for and conse-
quences of proposed government action;
(b) Regulatory action shall not be undertaken un-
less the potential benefits to society for the regulation
outweigh the potential costs to society;
(c) Regulatory objectives shall be chosen to maxi-
mize the net benefits to society;
(d) Among alternative approaches to any given
regulatory objective, the alternative involving the
least net cost to society shall be chosen; and
(e) Agencies shall set regulatory priorities with the
aim of maximizing the aggregate net benefits to
society, taking into account the condition of the par-
ticular industries affected by regulations, the condi-
tion of the national economy, and other regulatory
actions contemplated for the future.
Sec. 3. Regulatory Impact Analysis and Review.
(a) In order to implement Section 2 of this Order,
each agency shall, in connection with every major
rule, prepare, and to the extent permitted by law
consider, a Regulatory Impact Analysis. Such Analy-
ses may be combined with any Regulatory Flexibility
Analyses performed under 5 U.S.C. 603 and 604.
(b) Each agency shall initially determine whether a
rule it intends to propose or to issue is a major rule,
provided that, the Director, subject to the direction of
the Task Force, shall have authority, in accordance
with Sections l(b) and 2 of this Order, to prescribe
criteria for making such determinations, to order a
rule to be treated as a major rule, and to require any
set of related rules to be considered together as a
major rule.
(c) Except as provided in Section 8 of this Order,
agencies shall prepare Regulatory Impact Analyses of
major rules and transmit them, along with all notices
595
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596
REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
of proposed rulemaking and all final rules, to the
Director as follows:
(1) If no notice of proposed rulemaking is to be
published for a proposed major rule that is not an
emergency rule, the agency shall prepare only a final
Regulatory Impact Analysis, which shall be transmit-
ted, along with the proposed rule, to the Director at
least 60 days prior to the publication of the major
rule as a final rule;
(2) With respect to all other major rules, the agency
shall prepare a preliminary Regulatory Impact Analy-
sis, which shall be transmitted, along with a notice of
proposed rulemaking, to the Director at least 60 days
prior to the publication of a notice of proposed
rulemaking, and a final Regulatory Impact Analysis,
which shall be transmitted along with the final rule
at least 30 days prior to the publication of the major
rule as a final rule;
(3) For all rules other than major rules, agencies
shall submit to the Director, at least 10 days prior to
publication, every notice of proposed rulemaking and
final rule.
(d) To permit each proposed major rule to be
analyzed in light of the requirements stated in Sec-
tion 2 of this Order, each preliminary and final
Regulatory Impact Analysis shall contain the follow-
ing information:
(1) A description of the potential benefits of the
rule, including any beneficial effects that cannot be
quantified in monetary terms, and the identification
of those likely to receive the benefits;
(2) A description of the potential costs of the rule,
including any adverse effects that cannot be quanti-
fied in monetary terms, and the identification of
those likely to bear the costs;
(3) A determination of the potential net benefits of
the rule, including an evaluation of effects that can-
not be quantified in monetary terms;
(4) A description of alternative approaches that
could substantially achieve the same regulatory goal
at lower cost, together with an analysis of this
potential benefit and costs and a brief explanation of
the legal reasons why such alternatives, if proposed,
could not be adopted; and
(5) Unless covered by the description required
under paragraph (4) of this subsection, an explana-
tion of any legal reasons why the rule cannot be
based on the requirements set forth in Section 2 of
this Order.
(e)(l) The Director, subject to the direction of the
Task Force, which shall resolve any issues raised
under this Order or ensure that they are presented to
the President, is authorized to review any prelimi-
nary or final Regulatory Impact Analysis, notice of
proposed rulemaking, or final rule based on the
requirements of this Order.
(2) The Director shall be deemed to have concluded
review unless the Director advises an agency to the
contrary under subsection (f) of this Section:
(A) Within 60 days of a submission under subsec-
tion (c)(l) or a submission of a preliminary Regula-
tory Impact Analysis or notice of proposed rulemak-
ing under subsection (cX2);
(B) Within 30 days of the submission of a final
Regulatory Impact Analysis and a final rule under
subsection (c)(2); and
(C) Within 10 days of the submission of a notice of
proposed rulemaking or final rule under subsection
(0(3).
(f)(l) Upon the request of the Director, an agency
shall consult with the Director concerning the review
of a preliminary Regulatory Impact Analysis or notice
of proposed rulemaking under this Order, and shall,
subject to Section 8(a)(2) of this Order, refrain from
publishing its preliminary Regulatory Impact Anal-
ysis or notice of proposed rulemaking until such
review is concluded.
(2) Upon receiving notice that the Director intends
to submit views with respect to any final Regulatory
Impact Analysis or final rule, the agency shall, sub-
ject to Section 8(a)(2) of this Order, refrain from
publishing its final Regulatory Impact Analysis or
final rule until the agency has responded to the
Director's views, and incorporated those views and
the agency's response in the rulemaking file.
(3) Nothing in this subsection shall be construed as
displacing the agencies' responsibilities delegated by
law.
(g) For every rule for which an agency publishes a
notice of proposed rulemaking, the agency shall in-
clude in its notice:
(1) A brief statement setting forth the agency's
initial determination whether the proposed rule is a
major rule, together with the reasons underlying that
determination; and
(2) For each proposed major rule, a brief summary
of the agency's preliminary Regulatory Impact Analy-
sis.
(h) Agencies shall make their preliminary and final
Regulatory Impact Analyses available to the public.
(i) Agencies shall initiate reviews of currently effec-
tive rules in accordance with the purposes of this
Order, and perform Regulatory Impact Analyses of
currently effective major rules. The Director, subject
to the direction of the Task Force, may designate
currently effective rules for review in accordance with
this Order, and establish schedules for reviews and
Analyses under this Order.
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APPENDIX I
597
jec. 4. Regulatory Review. Before approving any final
jor rule, each agency shall:
(a) Make a determination that the regulation is
clearly within the authority delegated by law and
consistent with congressional intent, and include in
the Federal Register at the time of promulgation a
memorandum of law supporting that determination.
(b) Make a determination that the factual conclu-
sions upon which the rule is based have substantial
support in the agency record, viewed as & whole, with
full attention to public comments in general and the
comments of persons directly affected by the rule in
particular.
Sec. 5. Regulatory Agendas.
(a) Each agency shall publish, in October and April
of each year, an agenda of proposed regulations that
the agency has issued or expects to issue, and cur-
rently effective rules that are under agency review
pursuant to this Order. These agendas may be incor-
porated with the agendas published under 5 U.S.C.
602, and must contain at the minimum:
(1) A summary of the nature of each major rule
being considered, the objectives and legal basis for
the issuance of the rule, and an approximate sched-
ule for completing action on any major rule for which
•he agency has issued a notice of proposed rule-
(2) The name and telephone number of a knowl-
edgeable agency official for each item on the agenda;
and
(3) A list of existing regulations to be reviewed
under the terms of this Order, and a brief discussion
of each such regulation.
(b) The Director, subject to the direction of the Task
Force, may, to the extent permitted by law:
(1) Require agencies to provide additional informa-
tion in an agenda; and
(2) Require publication of the agenda in any form.
Sec. 6. The Task Force and Office of Management and
Budget.
(a) To the extent permitted by law, the Director
shall have authority, subject to the direction of the
Task Force, to:
(1) Designate any proposed or existing rule as a
major rule in accordance with Section Kb) of this
Order;
(2) Prepare and promulgate uniform standards for
the identification of major rules and the development
of Regulatory Impact Analyses;
^ (3) Require an agency to obtain and evaluate, in
•connection with a regulation, any additional relevant
data from any appropriate source;
(4) Waive the requirements of Sections 3, 4, or 7 of
this Order with respect to any proposed or existing
major rule;
(5) Identify duplicative, overlapping and conflicting
rules, existing or proposed, and existing or proposed
rules that are inconsistent with the policies underly-
ing statutes governing agencies other than the issu-
ing agency or with the purposes of this Order, and, in
each such case, require appropriate interagency con-
sultation to minimize or eliminate such duplication,
overlap, or conflict;
(6) Develop procedures for estimating the annual
benefits and costs of agency regulations, on both an
aggregate and economic or industrial sector basis, for
purposes of compiling a regulatory budget;
(7) In consultation with interested agencies, pre-
pare for consideration by the President recommenda-
tions for changes in the agencies' statutes; and
(8) Monitor agency compliance with the require-
ments of this Order and advise the President with
respect to such compliance.
(b) The Director, subject to the direction of the Task
Force, is authorized to establish procedures for the
performance of all functions vested in the Director by
this Order. The Director shall take appropriate steps
to coordinate the implementation of the analysis,
transmittal, review, and clearance provisions of this
Order with the authorities and requirements pro-
vided for or imposed upon the Director and agencies
under the Regulatory Flexibility Act, 5 U.S.C. 601 et
seq., and the Paperwork Reduction Plan Act of 1980,
44 U.S.C. 3501 et seq.
Sec. 7. Pending Regulations.
(a) To the extent necessary to permit reconsidera-
tion in accordance with this Order, agencies shall,
except as provided in Section 8 of this Order, suspend
or postpone the effective dates of all major rules that
they have promulgated in final form as of the date of
this Order, but that have not yet become effective,
excluding:
(1) Major rules that cannot legally be postponed or
suspended;
(2) Major rules that, for good cause, ought to
become effective as final rules without reconsider-
ation. Agencies shall prepare, in accordance with
Section 3 of this Order, a final Regulatory Impact
Analysis for each major rule that they suspend or
postpone.
(b) Agencies shall report to the Director no later
than 15 days prior to the effective date of any rule
that the agency has promulgated in final form as of
the date of this Order, and that has not yet become
effective, and that will not be reconsidered under
subsection (a) of this Section:
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
(1) That the rule is excepted from reconsideration
under subsection (a), including a brief statement of
the legal or other reasons for that determination; or
(2) That the rule is not a major rule.
(c) The Director, subject to the direction of the Task
Force, is authorized, to the extent permitted by law,
to:
(1) Require reconsideration, in accordance with this
Order, of any major rule that an agency has issued in
final form as of the date of this Order and that has
not become effective; and
(2) Designate a rule that an agency has issued in
final form as of the date of this Order and that has
not yet become effective as a major rule in accordance
with Section Kb) of this Order.
(d) Agencies may, in accordance with the Adminis-
trative Procedure Act and other applicable statutes,
permit major rules that they have issued in final
form as of the date of this Order, and that have not
yet become effective, to take effect as interim rules
while they are being reconsidered in accordance with
this Order, provided that, agencies shall report to the
Director, no later than 15 days before any such rule
is proposed to take effect as an interim rule, that the
rule should appropriately take effect as an interim
rule while the rule is under reconsideration.
(e) Except as provided in Section 8 of this Order,
agencies shall, to the extent permitted by law, refrain
from promulgating as a final rule any proposed major
rule that has been published or issued as of the date
of this Order until a final Regulatory Impact Analy-
sis, in accordance with Section 3 of this Order, has
been prepared for the proposed major rule.
(0 Agencies shall report to the Director, no later
than 30 days prior to promulgating as a final rule
any proposed rule that the agency has published or
issued as of the date of this Order and that has not
been considered under the terms of this Order:
(1) That the rule cannot legally be considered in
accordance with this Order, together with a brief
explanation of the legal reasons barring such consid-
eration; or
(2) That the rule is not a major rule, in which case
the agency shall submit to the Director a copy of the
proposed rule.
(g) The Director, subject to the direction of the Task
Force, is authorized, to the extent permitted by law,
to:
(1) Require consideration, in accordance with this
Order, of any proposed major rule that the agency
has published or issued as of the date of this Order;
and
(2) Designate a proposed rule that an agency has
published or issued as of the date of this Order, as a
major rule in accordance with Section Kb) of this
Order.
(h) The Director shall be deemed to have deter-
mined that an agency's report to the Director under
subsections (b), (d), or (f) of this Section is consistent
with the purposes of this Order, unless the Director
advises the agency to the contrary:
(1) Within 15 days of its report, in the case of any
report under subsections (b) or (d); or
(2) Within 30 days of its report, in the case of any
report under subsection (f).
(i) This Section does not supersede the President's
Memorandum of January 29, 1981, entitled "Post-
ponement of Pending Regulations", which shall re-
main in effect until March 30, 1981.
0') In complying with this Section, agencies shall
comply with all applicable provisions of the Adminis-
trative Procedure Act, and with any other procedural
requirements made applicable to the agencies by
other statutes.
Sec. 8. Exemptions.
(a) The procedures prescribed by this Order shall
not apply to:
(1) Any regulation that responds to an emergency
situation, provided that, any such regulation shall be
reported to the Director as soon as it is practicable,
the agency shall publish in the Federal Register a
statement of the reasons why it is impracticable for
the agency to follow the procedures of this Order with
respect to such a rule, and the agency shall prepare
and transmit as soon as is practicable a Regulatory
Impact Analysis of any such major rule; and
(2) Any regulation for which consideration or recon-
sideration under the terms of this Order would con-
flict with deadlines imposed by statutes or by judicial
order, provided that, any such regulation shall be
reported to the Director together with a brief expla-
nation of the conflict, the agency shall publish in the
Federal Register a statement of the reasons why it is
impracticable for the agency to follow the procedures
of this Order with respect to such a rule, and the
agency, in consultation with the Director, shall ad-
here to the requirements of this Order to the extent
permitted by statutory or judicial deadlines.
(b) The Director, subject to the direction of the Task
Force, may, in accordance with the purposes of this
Order, exempt any class or category of regulations
from any or all requirements of this Order.
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APPENDIX I 599
Sec. 9. Judicial Review. This Order is intended only
to improve the internal management of the Federal
government, and is not intended to create any right
or benefit, substantive or procedural, enforceable at
law by a party against the United States, its agen-
cies, its officers or any person. The determinations
made by agencies under Section 4 of this Order, and
any Regulatory Impact Analyses for any rule, shall be
made part of the whole record of agency action in
connection with the rule.
Sec. 10. Revocations. Executive Orders No. 12044, as
amended, and No. 12174 are revoked.
RONALD REAGAN
THE WHITE HOUSE
February 17, 1981
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APPENDIX V
Regulatory Impact Analysis Guidance
A Regulatory Impact Analysis (RIA) should demon-
strate that a proposed regulatory action satisfies the
requirements of Section 2 of Executive Order No.
12291. To do so, it should show that:
• There is adequate information concerning the
need for and consequences of the proposed action;
• The potential benefits to society outweigh the
potential costs; and
• Of all the alternative approaches to the given
regulatory objective, the proposed action will
maximize net benefits to society.
The fundamental test of a satisfactory RIA is
whether it enables independent reviewers to make an
informed judgment that the objectives of Executive
Order No. 12291 are satisfied. An RIA that includes
all the elements described below is likely to fulfill
this requirement. Although variations consistent with
the spirit and intent of the Executive Order may be
warranted for some rules, most RIAs should include
these elements.
The guidance in this document is not in the form of
a mechanistic blueprint, for a good RIA cannot be
written according to a formula. Competent profes-
sional judgment is indispensable for the preparation
of a high-quality analysis. Different regulations may
call for very different emphases in analysis. For one
proposed regulation, the crucial issue may be the
question of whether a market failure exists, and
much of the analysis may need to be devoted to that
key question. In another case, the existence of a
market failure may be obvious from the outset, but
extensive analysis might be necessary to estimate the
magnitude of benefits to be expected from proposed
regulatory alternatives. The amount of analysis
(whether scientific, statistical, or economic) that a
particular issue requires depends on how crucial that
issue is to determine the best alternative and on the
complexity of the issue.
Regulatory analysis inevitably involves uncertain-
ties and requires informed professional judgments.
Whenever an agency has questions about such issues
as the appropriate analytical techniques to use or the
alternatives that should be considered, it should con-
sult with the Office of Management and Budget as
early in the analysis stage as possible.
This document is written primarily in terms of
proposed regulatory changes. However, it is equally
applicable to the review of existing regulations. In the
latter case, the regulation under review should be
compared to a baseline case of no regulation and to
reasonable alternatives.
Elements of a Regulatory Impact Analysis
Preliminary and final Regulatory Impact Analyses
of major rules should contain five elements. They are:
(1) a statement of the potential need for the proposal,
(2) an examination of alternative approaches, (3) an
analysis of benefits and costs, (4) the rationale for
choosing the proposed regulatory action, and (5) a
statement of statutory authority. These elements are
explained in Sections I-V below.
I. STATEMENT OF POTENTIAL NEED FOR
THE PROPOSAL
In order to establish the potential need for the
proposal, the analysis should demonstrate that (a)
market failure exists that is (b) not adequately re-
solved by measures other than Federal regulation.
A. Market Failure
The analysis should determine whether there exists
a market failure that is likely to be significant. Once
such market failure has been identified, the analysis
should show how adequately the regulatory alterna-
tives to be considered address the specified market
failure. The three major types of market failure are
externality, natural monopoly, and inadequate infor-
mation.
1. Externality. An externality occurs when one
party's actions impose uncompensated benefits or
costs on another outside the marketplace. Environ-
mental problems are a classic case of externality.
Another example is the case of common property
resources that may become congested or overused,
such as fisheries or the broadcast spectrum. A third
example is a "public good," such as defense or scien-
tific research, whose distinguishing characteristic is
that it is inefficient, or impossible, to exclude individ-
uals from its benefits.
2. Natural monopoly. Natural monopoly exists
where a market can be served at lowest cost only if
production is limited to a single producer. Local
telephone, gas, and electricity services are examples.
3. Inadequate information. The optimum, or ideal,
level of information is not necessarily the maximum
possible amount, because information, like other
goods, should not be produced when the costs of doing
so exceed the benefits. The free market does not*
653
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
necessarily supply an optimal level of information,
because information, once generated, can be dis-
seminated at little or no marginal cost, and because
it is commonly infeasible to exclude nonpayers from
reaping benefits from the provision of information by
others. Where market failure due to inadequate in-
formation is the rationale for government inter-
vention, a regulatory action to improve the availabil-
ity of information will ordinarily be the preferred
alternative.
The current state of knowledge about the econom-
ics of information is not highly developed. Therefore,
regulatory intervention to address an information
problem should only be undertaken where there is
substantial reason to believe that private incentives
to provide information are seriously inadequate and
that the specific regulatory intervention proposed will
provide net benefits for society.
In many circumstances, the availability of informa-
tion, while perhaps not optimal, is reasonably ade-
quate, so that attempts to regulate information are as
likely to make things worse as to make them better.
Information about a particular characteristic of a
product, for example, would be reasonably adequate if
ers could determine the existence of the charac-
tic by inspection of the product before purchase
(in the case of a frequently purchased product) by
use of the product. Even if the characteristic could
not be determined by buyers, government interven-
tion would not be warranted where sellers have
incentives to reveal the existence of the characteristic
to buyers. Sellers will have substantial incentives to
supply information about any characteristic that is
important to buyers and valued positively by them,
particularly if the level of the characteristic varies
between the products of one seller and another. In
these circumstances, sellers whose products rank
highly in the valued characteristic can increase their
sales by informing buyers of the superiority of their
products. If the level of the characteristic does not
vary between the products of one seller and another,
individual sellers have less incentive to inform buyers
about the characteristic. Even so, the incentives of
individual sellers or of a trade association to supply
information may be substantial.
Sellers are least likely to supply adequate informa-
tion about a particular characteristic of their product
where the characteristic is negatively valued by con-
sumers and the level of the characterstic does not
vary between the products of one seller and those of
other (e.g., cholesterol in eggs). Even in such cir-
istances, substantial information about the char-
eristic may be available to buyers. For example,
sellers of rival products may supply the information
(e.g., while sellers of butter may have no incentive to
tell buyers about cholesterol in butter and its possible
consequences, sellers of margarine do have such an
incentive). Where the negative characteristic involves
a health or safety hazard, the threat of future prod-
uct liability lawsuits may give sellers adequate incen-
tives to reveal information about the potential haz-
ard. News media, consumer groups, public health
agencies, and similar services may supply informa-
tion not supplied by sellers. In summary, while it is
possible to identify situations in which market failure
due to inadequate information is more likely to war-
rant regulatory intervention, each situation must be
examined on a case-by-case basis.
There should be a presumption against the need for
certain types of regulatory actions, except in special
circumstances. A particularly demanding burden of
proof is required to demonstrate the potential need
for any of the following types of regulations:
• Price controls in competitive markets
• Controls on production or sales in competitive
markets
• Mandatory uniform quality standards for goods or
services, unless they have hidden safety or other
defects and the problem cannot be adequately
dealt with by voluntary standards or information
disclosing the hazard to potential buyers or users
• Controls on entry into employment or production,
except (a) where indispensable to protect health
and safety (e.g., FAA tests for commercial pilots)
or (b) to manage the use of common property
resources (e.g., fisheries, airwaves, Federal lands,
and offshore areas).
B. Alternatives to Federal Regulation
Even where a market failure exists, there may be
no need for Federal regulatory intervention if other
means of dealing with the market failure resolve the
problem adequately or better than the proposed Fed-
eral regulation would. Among the alternative means
that may be applicable are the judicial system
(particularly liability cases to deal with health and
safety), antitrust enforcement, and workers' compen-
sation systems.
An important alternative that may often be rele-
vant is regulation at the State or local level. In
determining whether there exists a potential need for
a proposed Federal regulation, the analysis should
examine whether regulation at the Federal level is
more appropriate than regulation at the State or local
level. This analysis may support regulation at the
Federal level where rights of national citizenship
(such as legal equality among the races) or considera-
tions of interstate commerce are involved. If inter-
state commerce is involved the analysis should at-
tempt to determine whether the burdens on
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655
interstate commerce arising from different State and
local regulations are so great that they outweigh the
advantages of diversity and local political choice. In
some cases, the nature of the market failure may
itself suggest the most appropriate governmental
level of regulation^ For example, pollution that spills
across state lines (such as acid rain whose precursors
are transported widely in the atmosphere) is probably
best controlled by Federal regulation, while localized
pollution (such as garbage truck noise) is probably
more efficiently handled by local government regula-
tion.
In general, because demands among localities for
different governmental services differ and because
competition among governmental units for taxpayers
and citizens may encourage efficient regulation, the
smallest unit of government capable of correcting the
market failure should be chosen. This must, however,
be balanced against the possibility of higher costs
because national firms would be required to comply
with more than one set of regulations and because
administering similar regulations in more than one
governmental unit involves some costs of duplication.
Thus, some analysis may be necessary to determine
which level of government can most efficiently regu-
late a specific market failure.
If the analysis does suggest a potential need for a
Federal action, it should also consider alternatives of
nonregulatory Federal measures. For example, as an
alternative to requiring an action or the use of a
particular product, it may be more efficient to subsi-
dize it. Similarly, a fee or charge may be a preferable
alternative to banning or restricting a product or
action. An example would be an effluent discharge
fee, which has been recommended as an efficient way
to limit pollution, because it causes pollution sources
with different marginal costs of abatement to control
effluents in an efficient manner. In addition, legisla-
tive measures that make use of economic incentives,
such as changes in insurance provisions or changes in
property rights, should be considered.
IL AN EXAMINATION OF ALTERNATIVE
APPROACHES
The RIA should show that the agency has consid-
ered the most important alternative approaches to
the problem and must provide the agency's reasoning
for selecting the proposed regulatory change over
such alternatives. Ordinarily, it will be possible to
eliminate some alternatives by a preliminary analy-
sis, leaving a manageable number of alternatives to
be evaluated by .quantitative benefit-cost analysis
according to the principles to be described in Section
HI. The number and choice of alternatives to be
selected for detailed benefit-cost analysis is unavoid-
ably a matter of judgment. There must be some
balance between thoroughness of analysis and prac-
tical limits to the agency's capacity to carry out
analysis.
Alternative regulatory actions that should be ex-
plored include the following:
1. More performance-oriented standards for health,
safety, and environmental regulations. Performance
standards are generally to be preferred to engineer-
ing or design standards because they allow the regu-
lated parties to achieve the regulatory objective in
the most cost-effective way. In general, a performance
standard should be preferred wherever that perfor-
mance can be measured or reasonably imputed. Per-
formance standards should also be applied as broadly
as possible without creating too much variation in
regulatory benefits; for example, by setting emission
standards on a plant-wide or firm-wide basis rather
than source by source. It is misleading and inappro-
priate, however, to characterize a standard as a
performance standard if it is set so that there is only
one feasible way to meet it; as a practical matter,
such a standard is a design standard.
2. Different requirements for different segments of
the regulated population. For example, there might be
different requirements for large and small firms. If
such a differentiation is made, it should be based on
perceptible differences in the costs of compliance or in
the benefits to be expected from compliance. For
example, some worker safety measures may exhibit
economies of scale, that is, lower costs per worker
protected in large firms than in small firms. A heav-
ier burden should not be placed on one segment of
the regulated population on the grounds that it is
better able to afford the higher cost; this is a sure
formula for loading disproportionate costs on the
most productive sectors of the economy.
3. Alternative levels of stringency. In general, both
the benefits and costs associated with a regulation
will increase with the level of stringency (although
costs will eventually increase more rapidly than bene-
fits). It is important to consider alternative levels of
stringency to better understand the relationship
between stringency and benefits and costs. This
approach will increase the information available to
the decisionmaker on the option that.maximizes net
benefits.
4. Alternative effective dates of compliance. The
timing of a regulation may also have an important
effect on its net benefits. For example, costs of a
regulation may vary substantially over different com-
pliance dates for an industry that requires a year or
more to plan its production runs efficiently. In this
instance, a regulation whose requirements provide
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
sufficient lead time is likely to achieve its goals at a
much lower overall cost than a regulation that is
effective immediately.
5. Alternative methods of ensuring compliance.
Compliance alternatives include the appropriate en-
tity (local, State, or Federal) enforcing compliance,
whether compliance is enforced hy on-site inspection
or periodic reporting, and structuring compliance
penalties so that they provide the most appropriate
incentives.
6. Informational measures. Measures to improve
the availability of information include government
establishment of a standardized testing and rating
system (the use of which could be made mandatory or
left voluntary), mandatory disclosure requirements
(e.g., by advertising, labeling, or enclosures), and
government provision of information (e.g., by govern-
ment publications, telephone hot-lines, or public in-
terest broadcast announcements). If intervention is
necessary to address a market failure arising from
inadequate information, informational remedies will
generally be the preferred approaches. As an alterna-
tive to a mandatory standard, a regulatory measure
to improve the availability of information has the
Kvantage of being a more market-oriented approach.
us, providing consumers information about con-
cealed characteristics of consumer products gives con-
sumers a greater choice than banning these products
(for example, consumers are likely to benefit more
from information on energy efficiency than from a
prohibition on sale of appliances or automobiles fall-
ing below a specified standard of energy efficiency).
Except for prohibiting indisputably false state-
ments (whose banning can be presumed beneficial),
specific informational measures must be evaluated in
terms of their benefits and costs. Paradoxically, the
current state of knowledge does not generally permit
the benefits and costs of informational remedies to be
measured very accurately. Nonetheless, it is essential
to consider carefully the costs and benefits of alterna-
tive informational measures, even if they cannot be
quantified very precisely. Some effects of informa-
tional measures can easily be overlooked. For exam-
ple, the costs of a mandatory disclosure requirement
for a consumer product include not only the obvious
cost of gathering and communicating the required
information, but also the loss of any net benefits of
information displaced by the mandated information,
the cost of any inaccurate consumer interpretation of
mandated information, and any inefficiencies
sing from the incentive that mandatory disclosure
a particular characteristic gives to producers to
overinvest in improving that specific characteristic of
their products.
Where information on the benefits and costs of
alternative informational measures is insufficient to
provide a clear choice between them, as will often be
the case, the least intrusive alternative, sufficient to
accomplish the regulatory objective, should be chosen.
For example, it will often be sufficient for government
to establish a standardized testing and rating system
without mandating its use, because firms that score
well according to the system will have ample incen-
tive to publicize the fact.
7. More market-oriented approaches. In general,
alternatives that provide for more market-oriented
approaches, with the use of economic incentives re-
placing command-and-control requirements, should
be explored. Market-oriented alternatives that may
be considered include fees, subsidies, penalties,
marketable rights or offsets, changes in liabilities or
property rights, and required bonds, insurance or
warranties (in many instances, implementing these
alternatives will require legislation).
ANALYSIS OF BENEFITS AND COSTS
A. General Principles
The preliminary analysis called for by Sections I
and II should have narrowed the number of alterna-
tives to be considered by quantitative benefit-cost
analysis to a workable number. Ordinarily, one of the
alternatives will be to promulgate no regulation at
all, and this alternative will commonly serve as the
base from which increments in benefits and costs are
calculated for the other alternatives. Even if alterna-
tives such as no regulation are not permissible statu-
torily, it is often desirable to evaluate the benefits
and costs of such alternatives to determine if statu-
tory change would be desirable. Departments and
agencies bear a similar burden when they perform
environmental impact statements in which alterna-
tives that lie outside their statutory authority must
be considered.
In some cases, the desirability of specific alterna-
tives outside the scope of the agency's regulatory
authority may be determined by use of basic eco-
nomic concepts in light of the principles enumerated
in Section I. In other instances, however, only a
quantitative benefit-cost analysis can resolve the
question, and such alternatives will need to be in-
cluded in the analysis of this section. In addition,
alternative forms of agency regulation will need to be
evaluated by quantitative benefit-cost analysis.
1. Evaluation of Alternatives. Except where prohib-
ited by law, the primary criterion for choice among
alternatives is expected net benefit (benefits minus
costs). Other criteria may sometimes produce equiva-
lent results, but they must be used with care to avoid
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APPENDIX V
657
the potentially serious pitfalls to be explained in Part
B of this section and in Section IV. Both benefits and
costs should be expressed in discounted constant
dollars. Appropriate discounting procedures are dis-
cussed in the following section.
The distinction between benefits and costs in bene-
fit-cost analysis is somewhat arbitrary, since a posi-
tive benefit may be considered a negative cost, and
vice versa, without affecting the net benefit (benefits
minus costs) decision criterion. This implies that the
considerations applicable to benefit estimates also
apply to costs and vice versa. The different issues are
considered separately under benefits or costs in Sec-
tions B and C below according to where they most
often arise.
If the proposed regulation is composed of a number
of distinct provisions, it is important to evaluate the
benefits and costs of the different provisions sepa-
rately. The interaction effects between separate provi-
sions (such that the existence of one provision affects
the benefits or costs arising from another provision)
may complicate the analysis but does not eliminate
the need to examine provisions separately. In such a
case, the desirability of a specific provision may be
appraised by determining the net benefits of the
proposed regulation with and without the provision in
question. Where the number of provisions is large
and interaction effects are pervasive, it is obviously
impractical to analyze all possible combinations of
provisions in this way. Some judgment must be used
to select the most significant or suspect provisions for
such analysis.
2. Discounting. The monetary values of benefits
and costs occurring in different years should be
discounted to their present values so that they are
comparable. This is not the same as correcting for
inflation. An inflation adjustment is made with a
price index, whereas discounting to present value is
done with a discount rate. Benefits and costs ex-
pressed in constant (i.e., unaffected by inflation) dol-
lars must further be discounted to present values
before benefits and costs in different years can be
added together to determine overall net benefits. As
an equivalent alternative to discounting non-
monetized benefits, the RIA may use the discount
rate to annualize (amortize) costs over a period that
corresponds to the occurrence of the benefits. Regard-
less of the discounting procedure selected, the RIA
must contain a schedule indicating when the benefits
and costs occur.
Discounting takes account of the fact that resources
(goods or services) in a given year are worth more
than identical resources in a later year. The underly-
ing reason for this is that resources can be invested
so as to return more resources later. Partly because
of this productivity of investment, individuals value
consumption in earlier years higher than consump-
tion in later years.
Modern analysis of discounting for public programs
stresses the distinction between two rates of return:
• The before-tax rate, also known as the opportunity
cost of capital. This is the real rate of return to
marginal private investments. Estimates of the
opportunity cost of capital in the U.S. economy
vary substantially. The 10 percent discount rate
specified by OMB Circular A-94 for use in evalu-
ating government programs is intended to repre-
sent the opportunity cost of capital.
• The after-tax rate, also known as the consumption
rate of interest. This represents the rate at which
consumers would be willing to exchange present
for future consumption, that is, the rate at which
consumers must be compensated for postponing
their consumption. As with the opportunity cost of
capital, alternative estimates of the consumption
rate of interest vary significantly. A rate of 4
percent is reasonably representative of the range
of alternative estimates and consistent with a 10
percent before-tax rate of return.
The basic concept underlying the academic litera-
ture on public-sector discounting is that economic
welfare is ultimately determined by consumption and
only indirectly by investment. Therefore, the value of
investment must be measured by the value of the
subsequent increase in consumption it permits. Any
effect that a government program has on investment
must be converted to an equivalent time-stream of
consumption before being discounted. In practice, this
results in a complex procedure that uses the before-
tax and after-tax discount rates, a "shadow price of
capital," and the impacts of benefits and costs on
investment. It is recommended that agencies continue
to use the well-understood procedure of discounting
by a single rate (as specified by OMB Circular A-94)
and, when appropriate, perform additional analysis
using the more complex shadow-price-of-capital meth-
odology.
There are two circumstances when it is important
to perform sensitivity analysis using the shadow price
of capital approach:
(a) Where the costs of the regulation are almost
entirely current costs borne by consumers. In such
circumstances, a low rate close to 4 percent is called
for. (This assumes, as is normally the case, that the
benefits are all in the form of disposable income or
other benefits directly to individuals.)
(b) Where some of the costs are capital costs
financed out of saving and there is a long period
between the time when most costs are incurred and
the time when most benefits accrue. In general, the
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
smaller the fraction of costs that are capital costs
financed out of saving and the longer the time period
between costs and benefits, the greater the likelihood
that the shadow price of capital approach will be
correct.
It is conceptually incorrect to adjust the discount
rate as a device to account for the uncertainty of
expected future benefits and costs. This procedure
will virtually never lead to a correct adjustment of
benefits and costs. Therefore, risk and uncertainty
should be dealt with according to the principles in
Section 3 below and not by changing the discount
rate.
3. Treatment of Risk and Uncertainty. Where uncer-
tainties exist about important parameters affecting
the expected benefits or costs of an alternative under
consideration, it is essential to carry out a sensitivity
analysis to determine the effect on net benefits of
plausible variations in the value of the parameters.
One form of sensitivity analysis involves calculation
of the "switch-point" value of the parameter under
examination, that is, the value of the parameter at
the break-even point at which the net-benefit decision
criterion switches over from favoring one alternative
Kfavoring another. When this break-even point of
parameter value is determined, the analysis may
n consider the probability that the true parameter
value is above or below the break-even value. For
example, if the major uncertainty about a proposed
regulation were its cost, the analysis could calculate
how high the cost would need to be in order to reduce
the net benefit of the proposal to zero. If it is judged
to be highly unlikely that the actual cost would be
that high or higher, it may be concluded that the
choice of the proposed alternative is not sensitive to
uncertainties about its cost.
A primary objective of sensitivity analysis is to
identify where additional analysis may be most
needed. If the choice of a specific regulatory action is
sensitive to alternative parameter values that are
about equally likely to be true, more research to
better determine the true parameter value could be
very valuable.
Wherever parameter estimates are uncertain, for
either benefits or costs, expected-value estimates
should be presented. Hypothetical best-case or worst-
case estimates may be presented as alternatives for
sensitivity analysis. Where possible, information
about the probability distribution of the parameter
estimate should be presented.
^A common situation that arises in estimating both
•refits and costs is that a number of different
itudies may exist which together provide a range of
different estimates for a particular parameter. In
general, it is not appropriate to use the midpoint of
the range of extreme values provided by the studies.
Such a technique ignores the information provided by
all studies except those providing the extreme values,
which may be the least reliable. The preferred ap-
proach to deriving an expected-value estimate of a
particular parameter in this situation would be to
derive it as a weighted average of the estimates of
the individual studies, with the weight of each esti-
mate being based on the reliability (in the best
judgment of the agency) of the study that produced it.
Where expected future benefits or costs are un-
certain, their value to those who receive them may be
different from their value if they were certain. (Often,
but not always, a certain future benefit is worth more
to people than an uncertain future benefit with the
same expected value.) As noted in the previous
section, it is incorrect to adjust the discount rate as a
device to account for the riskiness of future benefits
or costs. Any allowance for risk should be made by
adjusting the monetary values (for the year in which
they occur) of the uncertain benefits and costs so that
they are expressed in terms of their "certainty-
equivalents."
For an uncertain benefit in future year X, the
certainty-equivalent is the number of certain dollars
in year X that the uncertain benefit is worth to its
recipient. For example, suppose that a particular
regulation reduces the probability of fire in a particu-
lar type of facility. As part of a benefit-cost analysis
for this regulation, the dollar value of the expected
reduction in fire loss would be calculated. The owners
of the protected facilities place a higher dollar value
on the risk of a fire than the expected dollar value of
the loss. This is demonstrated by their willingness-to-
pay for fire insurance. Therefore, their relative net
cost (the percentage difference between insurance
premiums and insurance company claim payments)
for fire insurance can be used to increase the ex-
pected dollar value of the reduction in fire loss to its
certainty-equivalent value.
In the example of the preceding paragraph, the
adjustment for risk would involve an increase in the
value of the benefit, whereas uncertainty of a benefit
is normally thought to reduce its certainty-equivalent
value. The reason is that even though this benefit by
itself is uncertain, it acts to reduce the overall level
of risk that would prevail in the absence of the
regulation. This illustrates the important principle
that what matters is not the variability or riskiness
of a regulation's net benefits by themselves but the
regulation's effect on risk and uncertainty overall.
While an adjustment to account for risk may be
called for in the fire-risk example given, a similar
adjustment for the value of reductions in fatalities
and injuries would not be appropriate. Assuming that
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APPENDIX V
659
the values of fatalities and injuries have been derived
by the willingness-to-pay methodology recommended
in Section B.2 below, they would already represent
the certainty-equivalent value of the uncertain risk.
This is because the estimated dollar values represent
the certain dollar amounts that individuals would
sacrifice to reduce these risks.
Probably, in most cases, it will not be advisable to
adjust for risk and uncertainty. As a theoretical
matter, no adjustment for risk is necessary wherever
the net benefits are widely dispersed among many
individuals and are not correlated with disposable
income. And in cases where this does not apply, risk
may be relatively unimportant or may already be
taken into account by use of the willingness-to-pay
methodology. In other cases, there may be no practi-
cal way to quantify the value of changes in risk.
4. Assumptions. Where benefit or cost estimates are
heavily dependent on certain assumptions, it is es-
sential to make these assumptions explicit and,
where alternative assumptions are plausible, to carry
out sensitivity analyses based on plausible alterna-
tive assumptions. If the decision criterion proves to
be sensitive to alternative plausible assumptions, this
may necessitate further research to develop more
evidence on which of the alternative assumptions is
the most appropriate. Because the adoption of a
particular estimation methodology sometimes implies
major hidden assumptions, it is important to analyze
estimation methodologies carefully to make hidden
assumptions explicit.
5. International Trade Effects. In calculating the
benefits and costs of a proposed regulatory action,
generally no explicit distinction needs to be made
between domestic and foreign resources. If, for
example, compliance with a proposed regulation re-
quires the purchase of specific equipment, the oppor-
tunity cost of that equipment is ordinarily best repre-
sented by its domestic cost in dollars, regardless of
whether the equipment is produced domestically or
imported. The relative value of domestic and foreign
resources is correctly represented by their respective
dollar values, as long as the foreign exchange value of
the dollar is determined by a free exchange market.
Nonetheless, an awareness of the role of international
trade may be quite useful for assessing the benefits
and costs of a proposed regulatory action. For exam-
ple, the existence of foreign competition usually
makes the demand curve facing a domestic industry
more elastic than it would be otherwise. Elasticities
of demand and supply frequently can significantly
affect the magnitude of the benefits or costs of a
regulation.
A regulation that discriminates unjustifiably
against foreign exporters is a form of economic pro-
tectionism. The economic loss to the U.S. due to the
fact that protectionism is economically inefficient will
be reflected in the net benefit estimate of any prop-
erly conducted benefit-cost analysis. However, a bene-
fit-cost analysis will generally not be able to measure
the potential U.S. loss from the threat of future
retaliation by foreign governments. Therefore, special
attention should be given to any possibility that a
regulation would unjustifiably discriminate between
domestic and foreign producers and consumers—both
discrimination against foreigners and discrimination
in favor of foreigners.
The fact that a regulation has a differential effect
on foreigners as compared to Americans does not
necessarily constitute discrimination. If, for example,
an automobile safety standard could be complied with
less expensively by large cars than by small cars,
such a standard would be more favorable to American
car producers, who produce relatively more large cars
compared to the fleet mix of foreign producers. None-
theless, such a differential effect would not be dis-
criminatory if the difference in compliance cost
between large and small cars was necessary to
achieve legitimate regulatory objectives in the most
efficient way.
If a regulation has an adverse differential effect on
foreign producers or consumers relative to domestic
producers and consumers that is not necessary to
realize regulatory goals efficiently, then a discrimina-
tory effect on foreign trade exists. The RIA should
identify any substantial differential effect on interna-
tional trade and explain why it is necessary to
achieve legitimate regulatory goals in the most effi-
cient way. One means for reducing the likelihood of
international discrimination would be for a U.S. prod-
uct standard for an internationally traded good to be
based on an international standard, wherever an
international standard exists and is compatible with
the health, safety, or environmental needs of the U.S.
International harmonization can be beneficial for reg-
ulations directly setting standards for internationally
traded goods or services. For example, it would be
appropriate to consider international harmonization
in setting safety standards for automobiles. There is
no similar advantage to international harmonization
where a regulation does not directly affect the quality
of an internationally traded good or service, even if it
indirectly affects its costs (e.g., environmental con-
trols for automobile plants).
6. Distributional Effects. Those who bear the costs
of a regulation and those who enjoy its benefits often
are not the same persons. Benefits and costs of
regulation may also be distributed unevenly over
time, perhaps spanning several generations. There is
no generally accepted way to monetize potential
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
distributional effects. Attempts to incorporate dis-
tributional concerns in benefit-cost analysis require
the establishment of unequal weights for different
groups in society. Because positive economics treats
equally the willingness-to-pay of all individuals, any
alternative weighting would undermine the objective
character of the analysis. Policymakers may wish,
however, to take account of the distributional effects
of various regulatory alternatives. Therefore, where
there are potentially important differences between
those who stand to gain and those who stand to lose
under alternative regulatory options, the RIA should
identify these groups and indicate the nature of the
differential effects. The RIA should also present infor-
mation on the streams of benefits and costs over time
as well as present value estimates, particularly
where intergenerational effects are concerned.
B. Benefit Estimates
The RIA should state the beneficial effects of the
proposed regulatory change and its principal alterna-
tives. In each case, there should be an explanation of
the mechanism by which the proposed action is ex-
pected to yield the anticipated benefits. An attempt
jpuld be made to quantify all potential real incre-
ital benefits to society in monetary terms to the
mm extent possible. A schedule of monetized
benefits should be included that would show the type
of benefit and when it would accrue; the numbers in
this table should be expressed in constant, undis-
counted dollars. Any expected incremental benefits
that cannot be monetized should be explained.
The RIA should identify and explain in detail the
data or studies on which benefit estimates are based.
Where benefit estimates are derived from a statistical
study, the RIA must provide sufficient information so
that an independent observer can determine the rep-
resentativeness of the sample, whether it was extrap-
olated from properly in developing aggregate esti-
mates, and whether the results are statistically
significant.
For regulations addressing health and safety risks,
the calculation of potential benefits should derive
from the agency's estimate of the mean expected
value of the reduction in risk attributable to the
standard. Estimates of the prevailing level of risk
and of the reduction in risk to be anticipated from a
proposed standard should be unbiased expected-value
estimates rather than hypothetical worst-case esti-
mates. Extreme safety or health results should be
sighted (along with intermediate results) by the
T>bability of their occurrence to estimate the ex-
acted result implied by the available evidence. In
addition, to the extent possible, the distribution of
probabilities for various possible results should be
presented separately, so as to allow for an explicit
margin of safety, where required, in final decisions. If
a margin of safety is to be provided, the proper place
for it is the final stage of the decision-making pro-
cess, not by adjusting the risk or benefit estimates in
a conservative direction at the information-gathering
or analytical stages of the process. Conservative esti-
mates should be presented as alternatives to best
estimates for sensitivity analysis but should not sub-
stitute for them.
It is important to guard against double-counting of
benefits. For example, if a regulation improved the
quality of the environment in a community, the value
of real estate in the community might rise, reflecting
the greater attractiveness of living in the improved
environment. It would ordinarily be incorrect to in-
clude the rise in property values among the benefits
of the regulation. Ordinarily, the value of environ-
mental benefits (e.g., reduced health risks, scenic
improvements) will already be included among the
benefits. The rise in property values reflects the
capitalized value of these improvements. Therefore,
to count as benefits both the value of the environ-
mental improvements and the corresponding increase
in property values is to count the same benefits
twice. Only where a direct estimate of the benefits
has not been included would it be appropriate to
include the increase in property values among the
benefits.
1. General Considerations. The concept of "opportu-
nity cost" is the appropriate construct for valuing
both benfits and costs. The principle of "willingness-
to-pay" captures the notion of opportunity cost by
providing an aggregate measure of what individuals
are willing to forgo so as to enjoy a particular benefit.
Market transactions provide the richest database for
estimating benefits based on willingness-to-pay, so
long as the goods and services affected by a potential
regulation are traded in markets. Estimation prob-
lems arise in a variety of instances, of course, where
prices or market transactions are difficult to monitor.
Markets may not even exist in some instances, for-
cing regulatory analysts to develop appropriate prox-
ies that simulate market exchange. Indeed, the ana-
lytical process of deriving benefit estimates by
simulating markets may suggest alternative regula-
tory strategies that create such markets.
Willingness to pay always provides the preferred
measure of benefits. Estimates of willingness-to-pay
based on observable and replicable behavior deserve
the greatest level of confidence. Considerably less
confidence should be conferred on benefit estimates
that are neither derived from market transactions
nor based on behavior that is observable or replica-
ble. Of course, innovative benefit estimation method-
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APPENDIX V
661
ologies may be necessary in some cases, and should
be encouraged. However, reliance upon such methods
intensifies the need for quality control to ensure that
estimates derived conform as closely as possible to
what would be observed if markets existed.
2. Principles for Valuing Directly Observable Bene-
fits. Ordinarily, goods and services are to be valued at
their market prices. However, in some instances, the
market value of a good or service may not reflect its
true value to society. If a regulatory alternative
involves changes in such a good or service, its mone-
tary value for purposes of benefit-cost analysis should
be derived using an estimate of its true value to
society (often called its "shadow price"). For example,
suppose a particular air pollutant damages crops.
One of the benefits of controlling that pollutant will
be the value of the crop saved as a result of the
controls. If the price of that crop is held above the
free-market equilibrium price by a government price-
support program it will overstate the value of the
benefit of controlling the pollutant if the crop saved
were valued at the market price established by the
support program. The social value of the benefit
should be calculated using a shadow price for crops
subject to price supports. The estimated shadow price
should reflect the value to society of marginal uses of
the crop (e.g., the world price if the marginal use is
for exports). If the marginal use is to add to very
large surplus stockpiles, the shadow price would be
the value of the last units released from storage
minus storage cost. Therefore, where stockpiles are
large and growing, the shadow price is likely to be
low and could well be negative.
3. Principles for Valuing Benefits that are Indirectly
Traded in Markets. In some important instances, a
benefit corresponds to a good or service that is
indirectly traded in the marketplace. Important ex-
amples include reductions in the health-and-safety
risks, the use-value of environmental amenities and
scenic vistas, and savings in time. To estimate the
monetary value of such an indirectly traded good, the
willingness-to-pay valuation methodology is still con-
ceptually superior, because the amount that people
are willing to pay for a good or service is the best
measure of its value to them. As noted in Sections 4
and 5 immediately following, alternative methods
may be used where there are practical obstacles to
the accurate application of direct willingness-to-pay
methodologies.
A variety of methods have been developed for
estimating indirect benefits. Generally, these methods
apply statistical techniques to distill from observable
market transactions the portion of willingness-to-pay
that can be attributed to the benefit in question.
Examples include estimates of the value of environ-
mental amenities derived from travel-cost studies,
hedonic price models that measure differences or
changes in the value of land, and statistical studies of
occupational-risk premiums in wage rates.
Contingent-valuation methods have become in-
creasingly popular for estimating indirect benefits,
but they suffer from the fact that survey instruments
have a limited capacity to simulate real-world market
behavior. Benefit estimates derived from contingent-
valuation studies thus have a greater burden of
analytical care to ensure that they represent in an
unbiased manner what actually occurs in the market-
place.
4. Principles and Methods for Valuing Benefits that
are Not Traded Directly or Indirectly in Markets.
Some types of goods, such as the social benefit of
preserving environmental amenities apart from their
use and direct enjoyment by people, are not traded
directly or indirectly in markets. The practical obsta-
cles to accurate measurement are similar to (but
generally more severe than) those arising with re-
spect to indirect benefits, principally because there
are not market transactions to provide data for will-
ingness-to-pay estimates.
Contingent-valuation methods provide the only an-
alytical approaches currently available for estimating
the benefits of such untraded goods. The absence of
observable and replicable behavior with respect to the
benefit in question, combined with the difficulties of
avoiding bias in contingent-valuation studies, argues
for great care and circumspection in the use of such
methods. This means, for example, that estimates of
willingness-to-pay must incorporate the variety of
alternative means individuals have of expressing
value for untraded goods. Moreover, analyses must
faithfully capture individuals' budget constraints,
which restrict their willingness-to-pay for untraded
as well as traded goods and services. Benefit analyses
derived from contingent valuation and similar meth-
ods thus require considerable analytic rigor in design
and careful execution. Absent such efforts, analyses
based heavily on the benefits of untraded goods and
services ordinarily would fail the test of a satisfactory
RIA.
5. Methods for Valuing Health and Safety Benefits.
For health and safety benefits, a distinction should be
made between risks of nonfatal illness or injury and
fatality risks.
(a) Nonfatal illness and injury. Although the will-
ingness-to-pay approach is conceptually superior, the
current state of empirical research in the area is not
sufficiently advanced to assure that estimates derived
by this method are necessarily superior to direct-cost
valuations of reductions in risks of nonfatal illness or
injury. Any injury-value estimate from a willingness-
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
to-pay study is necessarily an average over a specific
combination of injuries of varying severity. If the
average injury severity in such a study is greatly
different from that for the regulatory action under
study, then the study's estimated injury value may
not be appropriate for evaluating that action. Accord-
ingly, the agency should use whichever approach it
considers most appropriate for the decision at hand.
The primary components of the direct-cost approach
are medical costs and the value of lost production.
Possibly important costs that may be omitted by the
use of the direct-cost approach are the value of pain
and suffering and the value of time lost from leisure
and other activities that are not economically directly
productive.
(b) Fatality. Reductions in fatality risks are best
monetized according to the willingness-to-pay ap-
proach. The value of changes in fatality risk is
sometimes expressed in terms of the "value of life."
This is something of a misnomer since the value of a
life really refers to the sum of many small reductions
in fatality risk. For example, if the annual risk of
death is reduced by one in a million for each of two
million people, that represents two "statistical lives"
aved per year (two million x one millionth = two). If
annual risk of death is reduced by one in 10
lion for each of 20 million people, that also repre-
sents two statistical lives saved. The conclusion that
the fatality risk reductions in these two cases are
equivalent implies an assumption. The implicit as-
sumption — that equal increments in risk are valued
equally — allows different risk increments to be added
together and compared directly. As a different exam-
ple, suppose there are two alternative reductions in
the annual risk faced by an individual:
A: from .10 x KT8 to .09 x 10^ = .01 x KT*
B: from 1.00 x IQr6 to .99 x 10"* = .01 x
Since in both cases the reduction in annual risk is
the same (.01 x 10~6), the value of A and B should be
considered the same.
The assumption that equal increments in fatality
risk are of equal value is a legitimate one, so long as
the level of fatality risk is below 10~* annually. There
is evidence that the willingness-to-pay value for
increments in fatality risk does not change signifi-
cantly over a wide range of risk exposure below 10~*
annually.
For levels of annual risk exposure of 10~* and above
lot be assumed that equal increments of risk
valued equally. At these higher risk levels, it is
ticularly important to distinguish between situa-
tions of voluntary risk assumption and those of invol-
untary risk. Where the high risk is involuntary, it is
appropriate to value reductions in risk from that high
level more highly than equal risk reductions at lower
risk levels. In general, the greater the risk that an
individual bears, the higher will be the value the
individual places on marginal changes in risk. On the
other hand, where a high risk is chosen voluntarily
those assuming the risk tend to be persons who place
a relatively low value on averting safety risks. Empir-
ical studies of risk premiums in high-risk occupations
suggest that reductions in voluntarily assumed high
risks should be valued less than equal risk reductions
at ordinary risk levels.
Estimates of the value of fatality risks refer only to
changes in an uncertain risk of death. They have no
application to the certain prevention of the death of
an identifiable individual.
6. Alternative Methodological Frameworks for Esti-
mating Health and Safety Benefits. Several alterna-
tive ways of incorporating fatality risks into the
framework of benefit-cost analysis may be appropri-
ate. These may involve either explicit or implicit
valuation of fatality risks.
One acceptable explicit valuation approach would
be for the agency to select a single value for reduc-
tions in fatality risk at ordinary risk levels (below
ICr4 annually) and use this value consistently for
evaluating all its programs that affect ordinary fatal-
ity risks. Another acceptable explicit valuation ap-
proach would be to use a range of values for reduc-
tions in fatality risk and apply sensitivity analysis as
with other parameters that have alternative plausible
values. The range of alternative values should be a
reasonable one, not one that includes the most ex-
treme upper and lower values of fatality risk reduc-
tion that have been estimated. Extreme values are
more appropriate for instances of extraordinarily high
risks (above 10~* annually), with the extreme low
values being appropriate where voluntary assumption
of high risk leads to self-selection and the extreme
high values being appropriate where the high risk is
involuntarily assumed.
Where the analysis uses a range of alternative
values for reductions in fatality risk, it may be useful
to calculate break-even values, as in other sensitivity
analyses. This requires calculating the borderline
value of reductions in fatality risk at which the net
benefit decision criterion would switch over from
favoring one alternative to favoring another (i.e., the
value of fatality risk at which the net benefits of the
two alternatives are equal). This method will fre-
quently be infeasible because of its computational
demands or because alternatives are continuous
rather than discrete (e.g., alternative stringencies for
exposure levels), but where appropriate, it is a useful
supplement to the sensitivity analysis.
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APPENDIX V
663
An implicit valuation approach could entail calcula-
tions of the cost per unit of reduction in fatality risk
(cost per "statistical life saved"), with costs defined as
costs minus monetized benefits. This must be used
with care since there is a serious potential pitfall: It
is not correct to choose between two mutually exclu-
sive alternatives by selecting the alternative with
lowest cost per statistical life saved. The alternative
with higher cost per life saved may nonetheless be
the alternative with the higher net benefit to society.
The way to avoid this pitfall while retaining the
implicit valuation approach is to make all calcula-
tions of cost per life saved in terms of increments
between alternatives. Alternatives should be arrayed
in order of their total reduction in expected fatalities
and the incremental cost per life saved calculated
between each adjacent pair of alternatives. In con-
trast to explicit valuation approaches, this avoids the
necessity of specifying in advance a value for reduc-
tions in fatality risks. However, a range of values will
be implied by the final selection of an alternative.
This range should be consistent with estimated val-
ues of reductions in fatality risks calculated according
to the willingness-to-pay methodology.
Another way of expressing reductions in fatality
risks is in terms of life-years saved. For example, if a
regulation protected individuals whose average re-
maining life expectancy was 40 years, then a risk
reduction of one fatality would be expressed as 40
life-years saved. Such a refinement may be desirable
for regulations that disproportionately protect young
people (e.g., motor vehicle safety regulations) or el-
derly people (e.g., regulations controlling carcino-
gens). To derive the value of a life-year saved from an
estimate of the value of life, first determine the
average remaining life expectancy of the sample pop-
ulation in the study from which the estimate was
drawn. Assuming that the average age of the sample
population is known, the average remaining life ex-
pectancy may be derived from actuarial tables giving
life expectancy in relation to age. Using standard
compound interest tables, the value of a life-year
saved can then be determined as the estimated value
of life annualized over a period equal to the number
of years of remaining average life expectancy.
C. Cost Estimates
1. General Considerations. The opportunity cost of
an alternative is the value of the benefits foregone as
a consequence of that alternative. For example, the
opportunity cost of banning a product (e.g., a drug,
food additive, or hazardous chemical) is the foregone
net benefit of that product. It is measured by changes
in producers' and consumers' surpluses. (Producers'
surplus is the difference between the amount a
producer is paid for a unit of a good and the mini-
mum amount the producer would accept to supply
that unit. It is measured by the distance between the
price and the supply curve for that unit. Consumers'
surplus is the difference between what a consumer
pays for a unit of a good and the maximum amount
the consumer would be willing to pay for that unit. It
is measured by the distance between the price and
the demand curve for that unit.) As another example,
even if a resource required by regulation does not
have to be paid for because it is already owned by the
regulated firm, nonetheless, the use of that resource
to meet the regulatory requirement has an opportu-
nity cost equal to the net benefit it would have
provided in the absence of the requirement. Any such
foregone benefits for an alternative should be mone-
tized wherever possible and either added to the costs
or subtracted from the benefits of that alternative.
Any costs that are averted as a result of an alterna-
tive should be monetized wherever possible and ei-
ther added to the benefits or subtracted from the
costs of that alternative.
All costs calculated should be incremental, that is,
they should represent changes in costs that would
occur if the regulatory alternative is chosen compared
to costs in the base case (ordinarily no regulation or
the existing regulation). Future costs that would be
incurred even if the regulation is not promulgated, as
well as costs that have already been incurred (sunk
costs), are not part of incremental costs. If
cost is not constant for any component of costs,
incremental costs should be calculated as the area
under the marginal cost curve over the relevant
range.
Costs include private-sector compliance costs, gov-
ernment administrative costs, .and costs of reallocat-
ing workers displaced as a result of the regulation.
Costs that are not monetary outlays must be included
and should be attributed a monetary value wherever
possible. Such costs may include the value (opportu-
nity cost) of benefits foregone, losses in consumers' or
producers' surpluses, discomfort or inconvenience,
and loss of time. A schedule of monetized costs should
be included that would show the type of cost and
when it would occur; the numbers in this table
should be expressed in constant, undiscounted dol-
lars. Any expected incremental costs that cannot be
monetized should be explained. An important type of
cost that often cannot be quantified is a slowing in
the rate of innovation or of adoption of new technol-
ogy. For example, regulations requiring a costly and
time-consuming approval process for new products or
new facilities may have such costs, as may regula-
tions setting much more stringent standards for new
facilities than existing ones.
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REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
Two accounting cost concepts that should not be
counted as costs in benefit-cost analysis are interest
and depreciation. The time value of money is already
accounted for by the discounting of benefits and costs.
Depreciation is already taken into account by the
time distribution of benefits and costs; the only legiti-
mate use for depreciation calculations in benefit-cost
analysis is to estimate the salvage value of a capital
investment.
2. Real Costs versus Transfer Payments. An impor-
tant, but sometimes difficult, problem in cost estima-
tion is to distinguish between real costs and transfer
payments. Transfer payments are not genuine costs
but payments for which no real good or service is
received in return. Several examples of problems that
may arise from the confusion between transfer pay-
ments and real costs (or benefits) may help to iden-
tify situations in which further analysis of the prob-
lem may be warranted. Monopoly profits, insurance
payments, government subsidies and taxes, and dis-
tribution expenses are four potential problem areas.
(a) Monopoly profits. If, for example, sales of a
competitively produced product were restricted by a
government regulation so as to raise prices to con-
lers, the resulting monopoly profits are not a
aefit of the rule, nor is their payment by consumers
a cost. The real benefit-cost effects of the regulation
would be represented by changes in producers' and
consumers' surpluses.
(b) Insurance payments. Potential pitfalls in bene-
fit-cost analysis may also arise in the case of insur-
ance payments, which are transfers. Suppose, for
example, a worker safety regulation, by decreasing
employee injuries, led to reductions in firms' insur-
ance premium payments. It would be incorrect to
count the amount of the reduction in insurance pre-
miums as a benefit of the rule. The proper measure
of benefits is the value of the reduction in worker
injuries, monetized as described previously, plus any
reduction in real costs of administering insurance
(such as the time of insurance company employees
needed to process claims) due to the reduction in
worker insurance claims. Reductions in insurance
premiums that are matched by reductions in insur-
ance claim payments are changes in transfer pay-
ments, not benefits.
(c) Indirect taxes and subsidies. A third instance
where special treatment may be needed to deal with
transfer payments is the case of indirect taxes (tariffs
or excise taxes) or subsidies on specific goods or
E' 88. Suppose a regulation requires firms to pur-
a $10,000 piece of imported equipment, on
i there is a $1,000 customs duty. For purposes of
benefit-cost analysis the cost of the regulation for
each firm ordinarily would be $10,000, not $11 000
since the $1,000 customs duty is a transfer payment
from the firm to the Treasury, not a real resource
cost. This approach, which implicitly assumes that
the equipment is supplied at constant costs, should
be used except in special circumstances. Where the
taxed equipment is not supplied at constant cost, the
technically correct treatment is to calculate how
many of the units purchased as a result of the
regulation are supplied from increased production
and how many from decreased purchases by other
buyers. The former units would be valued at the price
without the tax and the latter units would be valued
at the price including tax. This calculation is usually
difficult and imprecise because it requires estimates
of supply and demand elasticities, which are often
difficult to obtain and inexact. Therefore, this treat-
ment should only be used where the benefit-cost
conclusions are likely to be sensitive to the treatment
of the indirect tax. While costs ordinarily should be
adjusted to remove indirect taxes on specific goods or
services as described here, similar treatment is not
warranted for other taxes, such as general sales taxes
applying equally to most goods and services or in-
come taxes.
(d) Distribution expenses. The treatment of distri-
bution expenses is also a source of potential error.
For example, suppose a particular regulation raises
the cost of a product by $100 and that wholesale and
retail distribution expenses are on average 50 percent
of the factory-level cost. It would ordinarily be incor-
rect to add a $50 distribution markup to the $100
cost increase to derive a $150 incremental cost per
product for benefit-cost analysis. Most real resource
costs of distribution do not increase with the price of
the product being distributed. In that case, either
distribution expenses would be unchanged or, if they
increased, the increase would represent distributor
monopoly profits. Since the latter are transfer pay-
ments, not real resource costs, in neither case should
additional distribution expenses be included in the
benefit-cost analysis. However, increased distribution
expenses should be counted as costs to the extent
that they correspond to increased real resource costs
of the distribution sector as a result of the change in
the price or characteristics of the product.
D. Expenditure Rules
Regulations establishing terms or conditions of
Federal grants, contracts, or financial assistance call
for a different form of regulatory analysis than do
other types of regulation. In some instances, a full-
blown benefit-cost analysis may be appropriate to
inform Congress and the President more fully about
the desirability of the program, but this would not
ordinarily be required in a Regulatory Impact Analy-
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APPENDIX V
665
sis. The primary function of the RIA for this type of
regulation should be to verify that the terms or
conditions are the minimum necessary to achieve the
purposes for which the funds were appropriated.
They should not contain conditions in pursuit of goals
that are not germane to the purpose for which the
funds were authorized and appropriated. Beyond con-
trols to prevent abuse and to ensure that funds
appropriated to achieve a specific purpose are chan-
neled efficiently toward that end, maximum discre-
tion should be allowed in the use of Federal funds,
particularly when the recipient is a State or local
government.
IV. RATIONALE FOR CHOOSING THE
PROPOSED REGULATORY ACTION
The RIA should include an explanation of the
reasons for choosing the selected regulation. Ordinar-
ily, the regulatory alternative selected should be the
one that achieves the greatest net benefits. If legal
constraints prevent this choice, they should be identi-
fied and explained, and their net cost should be
estimated.
Where uncertainties are substantial or a large
proportion of benefits cannot be monetized, other
methods of summarizing the benefit-cost analysis
may sometimes be appropriate. When alternative
forms of presentation are used, the objective must
continue to be the maximization of net benefits (ex-
cept where prohibited by law). Alternative criteria
must be used with care because of the potential for
errors or misinterpretation.
Agencies need not calculate the internal rate of
return for a regulation. The internal rate of return is
often difficult to compute and is problematical when
multiple rates exist. It must not be used as a crite-
rion for choosing between mutually exclusive alterna-
tives. As a criterion for choosing between alternatives
that are not mutually exclusive, it has no advantages
over the criterion of maximizing the present value of
net benefits.
Benefit-cost ratios, if used at all, must be used with
care to avoid a common pitfall. It is a mistake to
choose among mutually exclusive alternatives by se-
lecting the alternative with the highest ratio of bene-
fits to costs. An alternative with a lower benefit-cost
ratio than another may have the higher net benefits.
Whether a regulation's benefits are greater (or less)
than its costs can be determined by whether its
benefit-cost ratio is greater (or less) than one. The
benefit-cost ratio may be used as a very simplified
indicator of the likely sensitivity of the result: If the
benefit-cost ratio is much greater than one, the con-
clusion that the regulation's benefits exceed its costs
probably is not sensitive to likely alternative param-
eter values. If the ratio is only slightly greater than
one, the conclusion probably is sensitive. The benefit-
cost ratio may sometimes be acceptable as a rough
substitute for genuine sensitivity analysis where it is
not feasible to carry out a full sensitivity analysis
(e.g., if the number of regulatory parameters to be
tested by sensitivity analysis is large). When so used,
the benefit-cost ratio should be recognized as only a
crude approximation to a genuine sensitivity analysis
and the analyst should be aware of its limitations
(e.g., the benefit-cost ratio is sensitive to the arbi-
trary classification of an item as a benefit or an
averted cost).
Where the benefits of proposed regulatory alterna-
tives include reductions in fatality risks, an accept-
able alternative to direct calculation of net benefits is
the indirect approach of calculating incremental costs
per life saved between adjacent alternatives. This is
done by ranking all the alternatives according to the
number of lives they save and then calculating the
change in costs and the change in lives saved be-
tween each alternative and the one with the next
highest number of lives saved. If the alternative
selected is the one whose incremental cost per life
saved is closest to the willingness-to-pay value of life,
this decision criterion is analytically equivalent to
that of maximizing net benefit.
In cases where important benefits cannot be as-
signed monetary values, cost-effectiveness analysis
should be used where possible to evaluate alterna-
tives that generate equivalent nonmonetizable bene-
fits. Costs should be calculated net of monetized
benefits. Between two alternatives with equivalent
nonmonetizable benefits, the alternative with the
lower net costs should be selected. Cost-effectiveness
analysis should also be used to compare regulatory
alternatives in cases where the level of benefits is
specified by statute.
V. STATUTORY AUTHORITY
The RIA should include a statement of determina-
tion and explanation that the proposed regulatory
action is within the agency's statutory authority.
Further Reading
Edith Stokey and Richard Zeckhauser, A Primer for
Policy Analysis. Chapters 9 and 10 provide a good
introduction to basic concepts.
E. J. Mishan, Economics for Social Decisions: Ele-
ments of Cost-Benefit Analysis. Assumes some knowl-
edge of economics. Chapters 6-8 should be helpful on
the important subjects of producers' and consumers'
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666 REGULATORY PROGRAM OF THE UNITED STATES GOVERNMENT
surpluses (not discussed extensively in this guidance the potential pitfalls associated with the use of con-
document), tingent-valuation methods.
W Kip ViBCusi^* By Choice. Chapter 6 is a good y j^ Smith Ed Mvances in ^lied Micro.
itfS"gJIOISJ L?6 P1C °f I ^ economics: Risk, Uncertainty, and the Valuation of
safety benefits Other more technical sources are
given in the bibliography. '
Robert Cameron Mitchell and Richard C. Carson, Judith D. Bentkover, Vincent T. Covello, and Jeryl
Using Surveys to Value Public Goods: The Contingent Mumpower, Eds., Benefits Assessment: The State of
Valuation Method. Provides a valuable discussion on the Art.
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